Court Orders Disgorgement of Taxes Avoided in Securities Fraud Case

The liabilities and remedies phases of the trial were bifurcated. I presided over a jury trial on nine of the ten claims from March 31 to May 7, 2014. On May 12, 2014, the jury returned a verdict against both Sam and Charles Wyly on all nine claims.¹ Following the jury verdict, I set a discovery and trial schedule for the remedies phase.

The SEC now seeks an order of disgorgement against Sam and Charles Wyly in the total amount of $619,298,512.45.² The SEC also seeks a civil penalty and injunctive relief against Sam Wyly. From August 4 to August 12, 2014, I held a bench trial on all remedies issues except the SEC's alternative disgorgement calculation based on trading profits from the sale of registered securities.³ For the benefit of all parties, I will now render a partial Opinion and Order addressing the remedies issues tried in August.

Pursuant to Rule 52(a) of the Federal Rules of Civil Procedure, I make the following findings of fact and conclusions of law. In reaching these findings and conclusions, I considered the testimony admitted during the jury and remedies trials, examined the documentary evidence, and reviewed the arguments and submissions of counsel, including a statement of interest filed on behalf of the United States government on August 9, 2014.

"Disgorgement serves to remedy securities law violations by depriving violators of the fruits of their illegal conduct."⁴ "[D]isgorgement forces a defendant to account for all profits reaped through his securities law violations and to transfer all such money to the court."⁵ Because disgorgement is an equitable remedy, "[t]he district court has broad discretion not only in determining whether or not to order disgorgement but also in calculating the amount to be disgorged."⁶ "In determining the amount of disgorgement to be ordered, a court must focus on the extent to which a defendant has profited from his" violation.⁷

Disgorgement, being an equitable remedy, is not subject to the five year statute of limitations under 28 U.S.C. § 2462. Under section 2462, "an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued. . . ." While the Second Circuit has not addressed the issue of whether disgorgement constitutes a civil forfeiture, it has specifically held that, due to its remedial nature, disgorgement does not constitute a penalty,⁸ and is not analogous to criminal forfeiture.⁹ Thus, "the great weight of the case law in this jurisdiction" supports the conclusion that disgorgement is "exempted from [s]ection 2462's limitations period."¹⁰

"Because of the difficulty of determining with certainty the extent to which a defendant's gains resulted from his frauds . . . the court need not determine the amount of such gains with exactitude."¹¹ Under Second Circuit law, "'[t]he amount of disgorgement ordered need only be a reasonable approximation of profits causally connected to the violation.'"¹² Disgorgement awards can include both "direct pecuniary benefit[s]" and "illicit benefits . . . that are indirect or intangible."¹³ However, because "disgorgement does not serve a punitive function, the disgorgement amount may not exceed the amount obtained through the wrongdoing."¹⁴

The SEC does not need to establish that the securities violations were the proximate cause of gains in order to satisfy the "causal connection" requirement. Unlike private plaintiffs, who must demonstrate that the defendants' misstatements or omissions were a proximate cause of their injury at the liability stage,¹⁵ the SEC has no such burden.¹⁶ Thus, the Second Circuit has held that "'[p]roximate cause' is the language of private tort actions[.] [I]t derives from the need of a private plaintiff, seeking compensation, to show that his injury was proximately caused by the defendants' actions. But, in an enforcement action . . . there is no requirement that the government prove injury, because the purpose of such actions is deterrence, not compensation."¹⁷

The same principles that led the Second Circuit to conclude that proximate cause is irrelevant in SEC enforcement actions at the liability phase apply to disgorgement. Disgorgement is "a distinctly public-regarding remedy, available only to government entities seeking to enforce explicit statutory provisions."¹⁸ "[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."¹⁹ Courts can compel defendants to disgorge all unlawful gains "even if [that figure] exceeds actual damages to victims."²⁰ Imposing a proximate cause requirement on the SEC at this stage of an enforcement proceeding and in light of this remedial framework would be inappropriate.

Nevertheless, because disgorgement is not punitive, the securities violations and the allegedly unlawful gains must be causally connected.²¹ This does not mean that a court is required to order disgorgement of all gains causally connected to the violations. For example, the Second Circuit has rejected disgorgement of income earned on unlawful proceeds, as unduly punitive.²² But the Second Circuit has held that district courts are not required to "trace specific funds" to specific violations when ordering disgorgement.²³ Rather, the appropriate inquiry is whether, and by how much, defendants "were unjustly enriched" by their securities law violations.²⁴

A recent Second Circuit case, SEC v. DiBella, is illustrative. Paul Silvester, the Connecticut State Treasurer, agreed to invest the state pension fund's money with an asset management firm in return for that firm agreeing to pay a "finder's fee" to Thomas DiBella, a former State Senator, who started his own consulting practice. "Silvester thought that allowing DiBella to be part of the . . . investment would . . . solidify[ ] a future business and political relationship."²⁵ After Silvester pled guilty to federal racketeering charges, the SEC brought an enforcement action against DiBella and his consulting company for aiding and abetting Silvester's securities fraud violations and the investment firm's violation of the Investment Advisers Act. The theory of liability for the primary violations was that Silvester and the investment firm defrauded the pension fund by failing to disclose the finder's fee arrangement.

A jury found DiBella and his company liable for aiding and abetting all violations, and the district court ordered disgorgement of the finder's fees. On appeal, defendants argued that disgorgement was inappropriate because the finder's fee did not result directly from the securities laws violations. That is, because the finder's fee was paid by the investment firm, and did not come from the pension fund itself, it could not have been "reaped through [the] securities laws violations."²⁶ The Second Circuit rejected defendants' theory, finding that DiBella was "unjustly enriched by aiding and abetting the [securities] violations," because "the fraud . . . was the linchpin necessary to ensure that [he] w[as] compensated."²⁷ Absent the fraud, DiBella "would not have been paid the fee at issue."²⁸

In other words, DiBella endorses a "but for" standard of causation. This method is consistent with the district court's analysis in Razmilovic, which was approved by the Second Circuit. In that case, the defendant perpetrated a massive accounting fraud in his company while he served as Chief Operating Officer and Chief Executive Officer. The district court ordered disgorgement of the defendant's bonuses because payment of bonuses was tied to the financial performance of the company. The court found that disgorgement of Razmilovic's bonuses was appropriate because the company's "restated earnings would not have met the target earnings amounts for performance-related bonuses in either year that he received those bonuses."²⁹ That is -- but for the defendant's fraud, the company would not have paid out bonuses. The court declined to award disgorgement of Razmilovic's entire salary based on similar reasoning. Because Razmilovic also provided legitimate services to the company, his fraud was not a "but for" cause of the receipt of his entire compensation package. In declining to order disgorgement of the entire salary, the court distinguished other cases where "the fraud committed by th[e] defendants extended the life of the employer-company and, therefore, the defendants would not have received any compensation from a company that would not have existed but for their fraud."³⁰

"Once the SEC has met the burden of establishing a reasonable approximation of the profits causally related to the fraud, the burden shifts to the defendant to show that his gains 'were unaffected by his offenses.'"³¹ Defendants are "entitled to prove that the [ ] measure is inaccurate,"³² but the "'risk of uncertainty in calculating disgorgement should fall upon the wrongdoer whose illegal conduct created that uncertainty.'"³³ Ultimately, however, the final decision as to the amount of disgorgement rests with the district court.³⁴

"For purposes of calculating disgorgement, financial hardship does not preclude the imposition of an order of disgorgement."³⁵ "[W]hether or not the defendant may have squandered and/or hidden ill-gotten profits should not determine the amount disgorged; similarly, the likelihood that the SEC will in fact be repaid is unrelated to the amount by which a wrongdoer was improperly enriched."³⁶

"Where an individual or entity has collaborated or worked closely with another individual or entity to violate the securities laws, those individuals and/or entities may be held jointly and severally liable for any disgorgement."³⁷ "In such situations, the joint tortfeasors bear the burden of demonstrating that their liability can be reasonably apportioned."³⁸

B. Prejudgment Interest

The court also has discretion to order payment of prejudgment interest on any disgorged gains. Requiring the payment of interest prevents a defendant from obtaining the benefit of "'what amounts to an interest free loan procured as a result of illegal activity.'"³⁹ "In deciding whether an award of prejudgment interest is warranted, a court should [take into account] . . . considerations of fairness and the relative equities of the award, [ ] the remedial purpose of the statute involved, and/or [ ] such other general principles as are deemed relevant by the court."⁴⁰

C. Civil Penalty

The Securities Act and the Exchange Act authorize three tiers of civil penalties.⁴¹ The parties agree that tier two penalties are appropriate because the violations found by the jury "involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement."⁴² "The amount of the penalty for each such violation shall not exceed the greater of [$60,000] or (ii) the gross amount of pecuniary gain to such defendant as a result of the violation."⁴³ "[C]ourts in this [d]istrict have calculated the number of violations based upon the number of acts taken that violate the securities laws, and the Second Circuit has endorsed that analysis."⁴⁴

For purposes of calculating a defendant's "gross pecuniary gain," the court "may consider gains only from frauds occurring within the five-year statute of limitations for civil penalties."⁴⁵ Otherwise, the calculation of "gross pecuniary gain" is similar to the calculation of disgorgement. "Beyond setting maximum penalties, the statutes leave 'the actual amount of the penalty . . . up to the discretion of the district court.'"⁴⁶

"[T]he civil penalty framework is of a 'discretionary nature' and each case 'has its own particular facts and circumstances which determine the appropriate penalty to be imposed.'"⁴⁷

The Securities Act and the Exchange Act authorize courts to permanently enjoin defendants from future violations of securities laws.⁴⁹ "An injunction prohibiting a party from violating statutory provisions is appropriate where 'there is a likelihood that, unless enjoined, the violations will continue.'"⁵⁰ Courts consider the following factors in determining whether a permanent injunction is appropriate relief:

"A grantor trust is created when a person contributes cash or property to a trust but retains certain interests such that he is treated as the owner of the trust."⁵² "In determining the settlors of a trust, [a court] look[s] beyond the named grantors to the economic realities to determine the true grantor."⁵³ "Assets held in a grantor trust are considered the property of the grantor. . . . thus making the trust assets taxable to the grantor, until those trust assets are distributed" to a beneficiary.⁵⁴

Sections 671-679 of Title 26 of the United States Code (the "Tax Code") govern the circumstances under which a grantor trust is created and taxed. "The main thrust of the grantor trust provisions is that the trust will be ignored and the grantor treated as the appropriate taxpayer whenever the grantor has substantially unfettered powers of disposition."⁵⁵ A trust does not become taxable "solely on the grounds of [the grantor's] dominion and control over the trust . . . except as specified in" these provisions.⁵⁶

Specifically, section 674(c), titled "Exception for certain powers of independent trustees" states

The substance over form doctrine is applicable to the entire body of federal tax law, including the grantor trust provisions.⁷¹ Thus, even when a trust is not a "sham" -- that is, where it has legitimate economic substance -- it may still be taxable as a grantor trust because it satisfies an exception within the grantor trust provisions only in form.⁷²

Between 1992 and 1996, Sam and Charles Wyly created a number of IOM trusts, each of which owned several subsidiary companies.⁷³ Michael French, the Wylys' family attorney, Sharyl Robertson, the Chief Financial Officer ("CFO") of the Wyly family office, and Michelle Boucher, the CFO of the Irish Trust Company, a Wyly-related entity in the Cayman Islands, served as protectors of the IOM trusts.⁷⁴ French, Robertson, and Boucher conveyed the Wylys' investment recommendations to the trust management companies administering the Wylys' IOM trusts (the "IOM trustees"). All of the IOM trustees' securities transactions were based on the Wylys' recommendations and the IOM trustees never declined to follow a Wyly recommendation.⁷⁵

The Wylys served as directors of Michaels Stores, Sterling Software, Sterling Commerce, and Scottish Annuity and Life Holdings, Ltd. ("Scottish Re").⁷⁶ As part of their compensation, the Wylys received stock options and warrants. "Between 1992 and 1999, Sam and Charles Wyly sold or transferred to the [IOM] trusts and companies stock options in Michaels Stores, Sterling Software and Sterling Commerce" in exchange for private annuities while simultaneously disclaiming beneficial ownership over the securities in public filings with the SEC.⁷⁷ Between 1995 and 2005, the IOM trusts and companies exercised these options and warrants, separately acquired options and stock in all four companies, and sold the shares, without filing disclosures.⁷⁸

The jury found⁷⁹ that the Wylys were beneficial owners of the Issuer securities transferred to, held, and sold by the IOM trusts because the Wylys, directly or indirectly, had or shared voting and/or investment power over these securities. Thus, the jury concluded that the Wylys failed to accurately disclose the extent of their beneficial ownership in the Issuer securities under sections 13(d) and 16(a) of the Securities Exchange Act (the "Exchange Act"). The jury also found that the Wylys caused the Issuers to violate section 14(a) of the Exchange Act, because the Wylys misrepresented the extent of their beneficial ownership to the Issuers in their Director and Officer ("D&O") questionnaires, which were incorporated by the Issuers in proxy statements. In addition to these disclosure violations, the Wylys were found liable for securities fraud in violation of section 10(b) of the Exchange Act and section 17(a) of the Securities Act of 1933 (the "Securities Act"), and for aiding and abetting the Issuers' and the IOM trusts' securities law violations. Finally, the jury found the Wylys liable for selling unregistered securities in violation of section 5 of the Securities Act for certain sales of Michaels Stores stock.

B. The Creation of the Offshore System

In early to mid-1991, Sam Wyly asked Robertson to attend a seminar held by lawyer and trust promoter David Tedder on the use of foreign trusts as a method of asset protection and tax deferral.⁸⁰ Shortly thereafter, the Wylys, Robertson, and French attended another Tedder seminar in New Orleans.⁸¹ Tedder, French, and the Wylys then had a private meeting at Sam Wyly's house in Malibu, California.⁸² At that meeting, Tedder "talked about establishing trusts that would provide tax deferral, and how the Wylys could transfer assets to those trusts and get tax deferral on the growth of those assets."⁸³ Specifically, Tedder recommended transferring the Wylys' stock options in Sterling Software and Michaels Stores to a foreign trust in exchange for a private annuity "in a tax-free kind of transaction."⁸⁴ Under Tedder's plan, it was "expressly intended that [the Wylys] . . . irrevocably surrender the enjoyment, control, ownership, and all economic benefits attributable to the ownership of the [options] which are sold in exchange for the private annuity."⁸⁵

The Wylys pursued the offshore program primarily for its tax advantages.⁸⁶ However, because Tedder suggested transferring stock options in publicly traded companies -- Sterling Software and Michaels Stores -- any such transaction would implicate the securities laws. French testified that he raised concerns about whether the Wylys would continue to have filing obligations as directors of Sterling Software and Michaels Stores, even after the transfers.⁸⁷ Tedder responded that making SEC filings could threaten the Wylys' tax benefits, because "disclosure of the offshore trusts in SEC filings may lead the IRS to discover and investigate the tax issue, and . . . the IRS might use the Wylys' SEC filings against them if the tax issue was ever litigated."⁸⁸

Defendants argue that French's testimony is not credible because his recollection of Tedder's statements came only after French reached a favorable settlement with the SEC on the eve of this trial.⁸⁹ Standing alone, French's testimony might not be credible. But Sam Wyly corroborated French's account by testifying that Tedder told him that SEC filings "could trigger tax problems if you had these things on file and [were] reporting the trust shares on [Schedule] 13Ds."⁹⁰ Further, it would be logical to draw an inference that the Wylys would have been concerned about taking inconsistent positions in their SEC and IRS filings when millions of dollars of tax savings were at stake.

The jury found that the Wylys always had beneficial ownership over the options, warrants, and securities held by the IOM trusts. Thus, the Wylys were obligated to disclose, on the filings required by sections 13 and 16, any time they or the trusts transacted in those securities. Because beneficial ownership under the securities laws turns on having voting and/or investment power, truthful SEC filings would have forced the Wylys to admit having some element of control over the securities held by the trusts. To the Wylys, this would mean conceding some element of control over the trustees. But the Wylys believed -- rightly or wrongly -- that it was critical to conceal their control of the trustees in order to maintain the tax-free status of the trusts, including income from transactions in the Issuer securities.⁹¹

Because the Wylys made public filings showing the transfer of options to foreign trusts, and at other times publicized their relationship to the foreign trusts,⁹² the Wylys also took affirmative steps to minimize the trusts' SEC filings to conceal the ultimate exercise and sale of those options. For example, the Wyly family office tracked the percentage of ownership each trust management company had in a particular Issuer to avoid triggering mandatory SEC reporting.⁹³ Thus, as Sam Wyly testified, not making SEC filings was logically "something that consistently went on" throughout the duration of the offshore system.⁹⁴

Even when it would have been otherwise helpful to assert beneficial ownership over the stock held by the foreign trusts, such as during Sam Wyly's proxy battle for control of Computer Associates (the acquirer of Sterling Software) in February 2002, the Wylys chose not to do it in fear of inconsistent tax positions.⁹⁵ From these facts, it is logical to draw the inference that making misleading statements in SEC filings, or not making SEC filings at all, was part of the Wylys' plan to maintain the appearance of separation and independence from the foreign trusts.⁹⁶

The following year, French asked Lubar to advise the Wylys about whether a trust settled by "a foreign person who had done business with Sam Wyly" would be treated as a grantor trust.¹⁰⁴ Lubar advised that "as long as there wasn't an indirect transfer of assets by the U.S. person and the foreign person put the money up, and there were certain powers in the trust, then it would be a foreign grantor trust, and the distributions then would not be taxable."¹⁰⁵ For the purposes of rendering his opinion, Lubar assumed that the foreign grantor would be the "sole transferor of property to the trust[ ]," unless the taxpayers transferred funds "on an 'arm's length' basis."¹⁰⁶

In 1994 and 1995, two foreign citizens established several trusts for the benefit of the Wylys and their families (collectively, the "Bessie Trusts").¹⁰⁷ The Bessie Trust and the Tyler Trust were purportedly settled by Keith King, an individual associated with Ronald Buchanan, an IOM trustee selected by the Wylys, with initial contributions of $25,000 each.¹⁰⁸ However, no such contribution was ever made. The trusts "were settled with a factual dollar bill . . . plus an indebtedness of $24,999 each on the part of Keith King as settlor."¹⁰⁹ That indebtedness was immediately forgiven.¹¹⁰

The La Fourche Trust and the Red Mountain Trusts were purportedly settled by Shaun Cairns, another individual associated with Buchanan, also with initial contributions of $25,000 each. Cairns testified that French prepared letters stating that Cairns was establishing the trusts "to show [his] gratitude for [the Wylys'] loyalty to our mutual ventures and [their] personal support and friendship,"¹¹¹ and asked Cairns to sign them.¹¹² In truth, Cairns had never met nor dealt with the Wylys before establishing the trusts, and had provided only $100 towards the trusts.¹¹³ Shortly after these trusts were settled, Cairns's trust management company was hired to serve as trustee for some of the Wylys' IOM trusts.¹¹⁴

These transactions were shams intended to circumvent the grantor trust rules. French and Buchanan, acting as the Wylys' agents, recruited King and Cairns to create a falsified record of a gratuitous foreign grantor trust. The trust documents are admittedly false -- King and Cairns never contributed $25,000 towards the initial settlement. Yet defendants argue that King and Cairns can still be considered grantors with contributions of $1 and $100, respectively, if those transfers were gratuitous and were never directly reimbursed by the Wylys.¹¹⁵

There were no gratuitous transfers here. First, I am doubtful that King provided even the factual $1 towards the trusts. In a November 26, 1995 fax to French, Buchanan writes that "Keith never produced the money."¹¹⁶ Buchanan explains that the King-related trusts "were settled with a factual dollar bill" only so that "there [was] no question of the[ ] [trusts] being voidable by reason of the absense of assets" pending the Wylys' transfer of options.¹¹⁷ Even if King had contributed the $1, the premise that an unreimbursed dollar bill is sufficient to establish a tax-free foreign grantor trust cannot be taken seriously. Second, Cairns's transfer of $100 cannot be considered gratuitous because shortly after settling these trusts, he received lucrative work from the Wylys as trustee.¹¹⁸ Finally, in light of the falsified trust deeds and supporting documentation surrounding these trusts, it would be unjust to consider anyone but the Wylys to be the true grantors of these trusts.

The SEC, on the other hand, has identified several transactions where the Wylys bypassed the trustees altogether. In October 2001, Keeley Hennington, who replaced Robertson as the head of the Wyly family office in June 2000, called Lehman Brothers and directed it to sell 100,000 shares of Michaels Stores held by Quayle Limited, an IOM company, at Charles Wyly's request. Neither Wyly nor Hennington contacted the trustees before placing the sell order.¹²⁰ On another occasion in June 2002, Sam Wyly contacted a broker directly and instructed him to "hold on" to 100,000 shares of TYCO stock, overriding a previous order from the IOM trustee, based on an earlier Wyly recommendation, to sell all TYCO shares.¹²¹

The SEC also presented evidence of transactions that no independent trustee would reasonably initiate. For example, on September 26, 1998, Boucher contacted an IOM trust to recommend a ten million dollar investment in the Edinburgh Fund. On September 28, Boucher told the trustee for the first time that the Edinburgh Fund was a fund run by Sam Wyly's son-in-law and that it did not have a prospectus or subscription documents. Despite knowing nothing about the investment beyond its connection to the Wyly family, the trustee agreed to "forward the necessary instructions to Lehman Brothers."¹²² One day later, Boucher followed up with the trustee "to ask for an update on progress with regard to making funds available for the proposed investment in the Edinburgh Fund. . . . [Boucher] mentioned that the Fund had already commenced trading and that the funds would therefore be required urgently."¹²³

Some of the Wylys' recommendations had nothing to do with securities at all. Among the many personal purchases, loans, and investments the Wylys directed the IOM trustees to make, were businesses for Wyly children and family members, real estate, artwork, jewelry, collectibles, and furniture.¹²⁴

In June 1997, French approached Morgan Lewis to discuss the tax consequences of the private annuity transaction.¹²⁷ Lubar remembers that he was "really concerned about the transaction" and "worried that the transfer of the options to a company that didn't have any other assets in exchange for a private annuity raised a question about whether that was an arms-length transfer."¹²⁸ However, Lubar acknowledged that "other tax lawyers would look at a transfer of a private annuity in different ways."¹²⁹ After studying the issue, Lubar advised French that the transfers created potential problems under sections 674 and 679, amongst other provisions.¹³⁰

C. Persuading Issuers Not to File Forms 1099 or W2

Ordinarily, a company granting stock options as compensation issues a Form 1099 or W2 reporting income to the director or officer and takes a corresponding deduction for the compensation expense when the option is exercised. When the Wylys transferred their stock options to the IOM trusts in exchange for private annuities, the Issuers of the options -- that is, Sterling Software and Michaels Stores -- had to decide whether that transfer was a taxable event that required issuing a Form 1099 or W2 to report income to the Wylys.¹³¹ To address these concerns, Tedder sent an opinion letter to both companies explaining that the Wylys should not have to recognize income because the annuity did not require payment until a date certain in the future.¹³²

Jeannette Meier, general counsel of Sterling Software, asked French's law firm, Jackson Walker, to give a "back up" tax opinion to support Tedder's letter. French provided a draft opinion, but never finalized the letter. Nevertheless, based on French and Tedder's representations, Sterling Software decided not to issue a Form 1099 to the Wylys and declined to take a corresponding deduction for compensation expense. But Meier testified that the company was "concerned about . . . whether, not having gotten a backup opinion from Jackson Walker, [it] was on good ground not to have to put [the compensation expense] in the [Section] 10-Q [financial statements.]"¹³³ The value of the options was "a big number" and "would have affected the accuracy of the public filings" if Sterling Software had decided to report it as compensation.¹³⁴

Michaels Stores treated the transfer of options identically. In addition, French instructed Mark Beasley, general counsel for Michaels Stores, not to issue Form 1099s for any of the foreign trust entities upon those companies' exercise of stock options.¹³⁵

In March 2000, SBC Communications Inc. ("SBC") acquired Sterling Commerce, which had been spun off from Sterling Software in 1995. "As part of [the] acquisition . . . all outstanding options to purchase shares of Sterling [Commerce] were canceled. All option holders received cash . . . based on the excess of the stock purchase price over the option price."¹³⁶ On January 11, 2001, SBC notified the Wylys that it was planning "to issue a Form 1099 to [the respective Wylys]/[their] trusts showing taxable income" in the total amount of $73,912,500.¹³⁷ The Wylys, through Boucher and Robertson, reached out to Rodney Owens, a partner at the Meadows Owens law firm in Dallas, to write a memo to SBC explaining why a 1099 should not be issued.¹³⁸ On January 26, 2001, Owens wrote in a letter to SBC that "it is not appropriate for SBC to file a 1099 or any other reporting papers regarding this transaction because [the IOM entity] is a foreign corporation, and the income from the purchase of the stock is not subject to U.S. taxation."¹³⁹ After receiving the letter, SBC sought additional information about the private annuity transaction, including whether the transfer of options had been recognized as a taxable event at the time of the original transaction, and if not, what the schedule of annuity payments was.¹⁴⁰ Although French's relationship with the Wylys had broken down by this point, he agreed to write a memorandum supporting the tax treatment of the annuities.¹⁴¹

All in all, between 1992 and 2004, the Issuers never reported income related to the exercise of options or warrants transferred to the foreign trusts.¹⁴² Their decision not to report was a result of the Wylys' deceptive behavior and affirmative misrepresentations. Because the Wylys disclaimed beneficial ownership of the options upon transfer, convinced the Issuers that the private annuity transactions were not taxable events, and did not disclose their beneficial ownership of the securities held by the IOM trusts in their Director and Officer questionnaires, the Issuers did not attribute taxable income to the Wylys.

D. Concerns about Taxation of Annuity Payments

The annuity payments for the original option transfers had been due to commence in the late 1990s, but that period was extended to 2004.¹⁴³ In early 2003, Boucher and Hennington approached Lubar to discuss potential issues arising from the upcoming annuity payments.¹⁴⁴ Lubar told Hennington and Boucher that, as he explained to French years before, he believed the trusts were grantor trusts under either sections 674 or 679 and should have been taxable to the Wylys all along. Further, Lubar believed the IRS would challenge the private annuity transactions.¹⁴⁵ Lubar and other Morgan Lewis attorneys suggested approaching the IRS "on a no-name basis" to see "where the negotiations with the IRS might lead" in the event the Wylys wanted to pursue a voluntary disclosure.¹⁴⁶

Boucher and Hennington summarized Lubar's advice in a July 2, 2003 memorandum to Sam Wyly, Charles Wyly, Evan Wyly, and Donald Miller. The memorandum addressed several concerns about the "logistical problems of paying the annuities."¹⁴⁷ Hennington and Boucher were concerned that "[i]t is almost certain given the large amount of these payments that the reporting will result in an IRS audit. [Further], [t]here is also a high likelihood that as a result of this audit the entire structure of the foreign system will be audited by the IRS."¹⁴⁸ Additionally, Hennington and Boucher reported that

According to attorney notes memorializing the meeting, an IRS officer asked if the taxpayers were "significant enough shareholders that their holdings would be listed on SEC filings" and asked if the "SEC filings show[ed] beneficial interest in shares."¹⁵¹ Lubar said that he believed they were significant enough shareholders for "at least [the] first two [companies]" but did not know if the filings showed beneficial ownership.¹⁵² Hennington and Boucher reported to the Wylys that the IRS was primarily interested in the structure of the annuity, but added that one of the IRS representatives "seemed very interested in any SEC reporting of the initial transactions [even though] [t]his seems out of their area of expertise or control."¹⁵³

E. IRS Audit

The Wylys did not proceed with Morgan Lewis on a voluntary disclosure path. But by February 2, 2004, Charles Wyly received a notice of audit.¹⁵⁴ Shortly thereafter, Sam Wyly asked Hennington, Boucher, and Charles Pulman, another attorney at Meadows Owens, "to explore what happens [for purposes of taxation] if he is not a U.S. citizen."¹⁵⁵ The firm concluded that an expatriate U.S. citizen who has a net worth of more than $622,000 "will be treated as having a principal purpose of tax avoidance" and will continue to be taxed pursuant to several special provisions.¹⁵⁶

From May to August 2004, the IRS sent a number of information document requests ("IDRs") to both Sam and Charles Wyly.¹⁵⁷ In at least one of the IDRs, the IRS requested additional information about a transfer of Michaels Stores options to an independent trust, such as "the identity of all original and current beneficiaries, including their nationality, place of residence, and current mailing address" as well as the identity of "the grantor(s) of the trust(s)."¹⁵⁸ At an October 21, 2004 meeting between attorneys representing the Wyly family and the IRS, an IRS agent said that the IDRs regarding the options transfers were based on information "pulled from SEC filings."¹⁵⁹ At that meeting, the IRS agents also asked questions about the trusts, including about why Keith King set up the Tyler Trust.¹⁶⁰

The SEC has not shown that the Wylys' or Issuers' SEC filings launched the IRS audit of the Wylys and the offshore system, or even that accurate filings would have been likely to trigger an earlier examination. However, it is evident from the IDRs and from the October 2004 meeting, that once the IRS investigation was under way, agents and investigators were consulting SEC filings as part of their fact finding process and identified numerous issues and misstatements.

F. Purchase and Sale of Unregistered Michaels Stores Stock

On December 26, 1996, Michaels Stores announced that it had entered into private agreements to sell two million options to purchase shares of unregistered stock to "independent trusts of which Wyly family members are beneficiaries."¹⁶³ On January 7, 1997, the Wall Street Journal reported on the purchase as a positive sign for Michaels Stores.¹⁶⁴ Between the date of the options purchase and the day after the Wall Street Journal article appeared, share price rose from $10.50 to $13.125.¹⁶⁵ The options were transferred on February 25, 1997, and exercised on March 10, 1997.¹⁶⁶ On that date, Michaels Stores closed at $17.625.¹⁶⁷

The IOM trusts sold 1.8 million shares of unregistered stock between June and December 1997, at prices ranging from approximately $21 per share in the summer to approximately $35 per share in the fall.¹⁶⁸ The trusts sold 200,000 of these shares less than one year after the December 1996 private placement, in violation of the terms of the purchase agreement.¹⁶⁹ In 1998, the IOM trusts sold a small number of shares at approximately $32 per share. In 2000 and 2001, the IOM trusts sold approximately 1.2 million shares at prices ranging from approximately $40 per share in September 2000 to approximately $55 per share in November 2001.¹⁷⁰

Defendants argue that the proper measure of disgorgement for sale of unregistered securities in this context should be the economic benefit attributable to the Wylys' failures to 1) cause Michaels Stores to register the securities and 2) file disclosures after the sales. Defendants attempted to calculate that economic benefit with expert testimony from Professor John J. McConnell, of the Purdue School of Management.

McConnell relied upon three academic studies -- a 2000 study by David Aboody and Baruch Lev, a 2001 study by Joseph Lakonishok and Inmoo Lee, and a 2010 study by Francois Brochet -- all of which purport to examine the economic impact of trading disclosures by officers and directors.¹⁷² These studies concluded that the adverse effect on share price associated with SEC filings disclosing insider sales ranges from .17 percent to .61 percent.¹⁷³ McConnell explained this fairly low price impact by concluding that while

The SEC challenges McConnell's conclusions as speculative because they are based on assumptions about the Wylys' hypothetical compliance with the securities laws. It is true that, like all experts, McConnell makes certain assumptions of fact. However, these assumptions -- that the Wylys 1) caused Michaels Stores to register the shares, and 2) made appropriate disclosures following the sales -- are not offered to speculate about a counter-factual universe. Rather, McConnell makes these assumptions in order to calculate the economic benefit the Wylys received for failing to do those things.

Nevertheless, McConnell's methodology is irredeemably flawed because the underlying studies he relies on are not applicable to the facts of this case. First, the studies evaluate the impact of disclosure by "garden variety" insiders -- that is, ordinary officers and directors. However, the Wylys were anything but "garden variety" insiders. During this time period, the Wylys owned over forty percent of the common stock in Michaels Stores,¹⁷⁷ and controlled five of the seven seats on the Board of Directors.¹⁷⁸ McConnell's statement that he had "no basis to conclude that the market reaction to the sale of the Wylys would have been significantly different than the average reaction identified in the economic literature" is indefensible in light of these facts.¹⁷⁹

At best, McConnell may argue that there was minimal market reaction to seventeen instances where the Wylys sold Michaels Stores stock domestically between 1993 and 2004 and extrapolate that the Wylys were "garden variety" insiders.¹⁸⁰ But I cannot draw conclusions from the small number of onshore transactions relative to the large volume of offshore (and undisclosed) transactions at issue here.¹⁸¹

Alternatively, McConnell points to the fact that there was minimal market reaction to the February 2005 disclosure that the Wylys were under investigation by the Manhattan District Attorneys' Office, and the April 2005 disclosure that the Wylys intended to amend their Schedule 13D filings to claim beneficial ownership of the shares remaining in the IOM trusts.¹⁸² But by this time the Wylys' joint holdings constituted only eight percent of the outstanding Michaels Stores common stock, so the impact of any disclosure would likely be lower.¹⁸³ More importantly, these disclosures -- of a criminal investigation and of an insider's beneficial ownership over additional shares held by foreign trusts -- are entirely different from the disclosures that would have been made in 1997-1998. Acknowledging beneficial ownership over common stock held by a trust is not comparable to an insider disclosing his sale of millions of shares.

Second, McConnell's calculation of price impact does not take into account the significantly discounted price at which the Wylys bought the unregistered securities.¹⁸⁴ The discount is evident for the April 1996 private placement, and can thus be inferred for the December 1996 option purchase. Michaels Stores closed trading on March 28, 1996 at $14.25.¹⁸⁵ The Wylys entered into an agreement to purchase two million shares on March 29, the same day as the press release announcing the cash infusion. By the time the Wylys actually purchased the shares on April 5, the price had risen to $15.35.¹⁸⁶ Thus, the Wylys bought the shares at a 22.8% discount,¹⁸⁷ a figure consistent with academic studies finding that "[a]verage discounts on unregistered shares are sizable, ranging from 20% to 35%."¹⁸⁸ For both of these reasons, I reject McConnell's methodology and valuation.

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.

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.¹⁹⁰ 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."¹⁹¹

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.¹⁹² "[A] tax is an enforced contribution to provide for the support of the government."¹⁹³ 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.

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.¹⁹⁴ 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."¹⁹⁵

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."¹⁹⁶ 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."¹⁹⁷ Disgorgement compels defendants to "give up the amount by which [they were] unjustly enriched."¹⁹⁸ 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,¹⁹⁹ and amounts equivalent to losses avoided as a result of the securities violations.²⁰⁰ Disgorgement "is a remedy that gives courts flexibility" to determine the appropriate remedy "to fit the wrongful conduct."²⁰¹

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."²⁰² I disagree. This case, like many others litigated before this Court, involves statutory interpretation and application of common law doctrines.²⁰³ 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.²⁰⁴

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.²⁰⁵

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."²¹² According to the corresponding IRS regulation, which summarizes the statute,

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.²¹⁴ 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."

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."²¹⁵ 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."

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.'"²¹⁶ 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."²¹⁷ 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.

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.²¹⁸

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.²¹⁹ 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."²²⁰ 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."²²¹ 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."²²²

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.²²³

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."²²⁴ 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.²²⁵ 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.²²⁶

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.²²⁷ 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."²²⁸ 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."²²⁹

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.²³¹

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."²³² 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."²³³

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.'"²³⁴ 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."²³⁵

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.²³⁶ 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.²³⁷ 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.²³⁸ For that reason, I decline to adopt the SEC's preferred IRS underpayment rate for the entire period.²³⁹ 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."²⁴⁰ I disagree.

Courts can consider the other remedies already imposed in determining whether a penalty would be unduly harsh under the circumstances.²⁴¹ 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.²⁴² I conclude that disgorgement of this magnitude is more than sufficient to deter future violations and, accordingly, I decline to impose additional penalties.

E. Injunction

The SEC also seeks a permanent injunction against future violations of sections 5 and 17(a) of the Securities Act and sections 13(a), 13(d), 14(a), 16(a) and 10(b) of the Exchange Act against Sam Wyly. The SEC contends that "[i]n the absence of injunctive relief, there is no assurance [Sam Wyly] will not violate the securities laws again"²⁴³ as his "vast wealth gives him the ability to purchase large ownership positions in publicly traded companies."²⁴⁴ Defendants argue that "[g]iven Sam Wyly's age, health, and current occupation, there is no real need to enjoin him from future violations."²⁴⁵

As another court in this district recently said, "the utility of this kind of 'obey-the-law' injunction" is limited because "everyone is required to obey the law, the law comes with its own penalties, and merely reciting statutory provisions gives an individual 'little guidance on how to conform his conduct to the terms of the injunction.'"²⁴⁶ The general toothlessness of permanent injunctions is evident from the facts of this very case. Sam Wyly engaged in a large securities fraud spanning thirteen years, involving multiple trusts and entities and hundreds, if not thousands, of misstatements, all while being subject to a previous injunction entered in 1979.²⁴⁷ Nevertheless, the extensiveness of this scheme, the brazenness of Wyly's conduct, and his position of wealth and importance in the community warrants the imposition of a permanent injunction in this case.

I have reviewed the parties' submissions and Dr. Becker's report. The SEC's request to leave the record open for the limited purpose of addressing this theory is granted. However, the SEC may only present Dr. Becker's first opinion, which approximates unlawful gains by "calculat[ing] the difference between the Wylys' gains from their offshore transactions in the Issuers' securities, and the gains that an ordinary buy and hold equity investor would have earned in those securities."²⁵³ Although defendants argue that this theory lacks a causal connection to the Wylys' securities violations, I disagree. Dr. Becker's "buy and hold" calculation approximates the economic value of the Wylys' securities violations -- that is, their ability to trade in secret while having an informational advantage over the investing public.²⁵⁴

Defendants' deadline to submit a rebuttal report is October 29, 2014. In lieu of depositions, the Court will hold a one day hearing on November 17, 2014, where the SEC and defendants may each have up to four hours to cross-examine the experts. Because the record is left open for a limited purpose and time is a significant concern, no further briefing will be accepted.

SO ORDERED.

DATED: September 24, 2014,

² The proposed order of disgorgement is based on the following calculations: 1) $193,913,017.77 in unpaid taxes for gains on the sale of registered Issuer securities, plus $289,089,876.68 in prejudgment interest, and 2) $65,395,151 in profits made on the sale of unregistered Michaels Stores stock, plus $70,900,467 in prejudgment interest. See Joint Exhibit ("JX") 9902 ("Calculations Using the Ordinary Tax Rate for All Transactions in Registered Issuer Securities Attributable to Sam and Charles Wyly") and Addendum to the Joint Pre-Trial Order ("Add. Stip. Facts") ¶ 6. The SEC provides an alternative estimation of unpaid taxes using a 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") (proposing disgorgement of $170,884,904.73 in unpaid taxes and $259,439,440.99 in prejudgment interest). Because the SEC seeks disgorgement of all profits on the sale of unregistered securities, it is not also seeking unpaid taxes on those profits, except as an alternative measure of disgorgement.

³See infra Section VI.

⁴SEC v. Contorinis, 743 F.3d 296, 301 (2d Cir. 2014).

⁵SEC v. Cavanagh, 445 F.3d 105, 117 (2d Cir. 2006).

⁶SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1474-75 (2d Cir. 1996).

⁷SEC v. Universal Exp., Inc., 646 F. Supp. 552, 563 (S.D.N.Y. 2009).

⁸See SEC v. Pentagon Capital Mgmt. PLC, 725 F.3d 279, 288 n.8 (2d Cir. 2013) (rejecting appellant's argument that "that the disgorgement award should be considered a penalty").

⁹See Contorinis, 743 F.3d at 306-07 ("[W]hile both criminal forfeiture and disgorgement serve to deprive wrongdoers of their illicit gain, the two remedies reflect different characteristics and purposes -- disgorgement is an equitable remedy that prevents unjust enrichment, and criminal forfeiture a statutory legal penalty imposed as punishment. . . . Moreover, unlike disgorgement, which is a discretionary, equitable remedy, criminal forfeiture is mandatory, and a creature of statute. Thus, unlike the criminal forfeiture case, the district court's discretion in determining disgorgement is not confined by precise contours of statutory language, but rather serves the broader purposes of equity."). In its discussion, the Second Circuit favorably cited a lower court decision in SEC v. Lorin, including that court's conclusion that disgorgement is not "'a fine, penalty, or forfeiture'" because it "'merely deprives one of wrongfully obtained proceeds.'" See id. at 307 (quoting SEC v. Lorin, 869 F. Supp. 1117, 1121 (S.D.N.Y. 1994)).

¹⁰SEC v. Straub, No. 11 Civ. 9645, 2013 WL 4399042, at *5 (S.D.N.Y. Aug. 5, 2013) (citing SEC v. Kelly, 663 F. Supp. 2d 276, 286-87 (S.D.N.Y. 2009) (collecting cases)). Defendants nevertheless contend, citing dictionary definitions but no case law, that the SEC's request for disgorgement constitutes "forfeiture" under section 2462. See Defendants' Memorandum of Law on Remedies ("Def. Mem."), at 33. Defendants raised an identical argument prior to the jury trial. I rejected it then for the same reasons I do now. See 3/24/14 Pre-Trial Conference Transcript, at 22-23 ("THE COURT: [I]t seems to me that neither disgorgement, injunctive relief, [n]or any other requested form of relief is subject to the limitations of 2462.").

¹¹SEC v. Razmilovic, 738 F.3d 14, 31 (2d Cir. 2013).

¹²Contorinis, 743 F.3d at 305 (quoting First Jersey, 101 F.3d at 1474-75) (emphasis added).

¹³Id. at 307.

¹⁴Id. at 301.

¹⁵See Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 346 (2005) (holding that private plaintiffs must "prove that the defendant's misrepresentation (or other fraudulent conduct) proximately caused the plaintiff's economic loss" in securities actions).

¹⁶See SEC v. KPMG LLP, 412 F. Supp. 2d 349, 375 (S.D.N.Y. 2006) ("The SEC, unlike a private plaintiff, is not required to prove reliance when it brings enforcement actions under the securities laws."). See also SEC v. Credit Bancorp, Ltd., 195 F. Supp. 2d 475, 490-91 (S.D.N.Y. 2002) ("The SEC does not need to prove investor reliance, loss causation, or damages" in enforcement actions).

¹⁷SEC v. Apuzzo, 689 F.3d 204, 212 (2d Cir. 2012) (emphasis added).

¹⁸FTC v. Bronson Partners, LLC, 654 F.3d 359, 372 (2d Cir. 2011).

¹⁹SEC v. Commonwealth Chem. Sec., Inc., 574 F.2d 90, 102 (2d Cir. 1978).

²⁰Cavanagh, 445 F.3d at 118. Defendants' reliance on the Supreme Court's recent decision in Paroline v. United States, 134 S. Ct. 1710, 1720 (2013), is unavailing in light of this distinction. In that case, the Court concluded that the mandatory restitution provision of the criminal laws governing child pornography laws can only require restitution "to the extent the defendant's offense proximately caused a victim's losses." Id. at 1722. But as explained above, the Second Circuit has already distinguished between disgorgement, a discretionary equitable remedy, and criminal restitution, which is mandatory and focuses on redressing actual losses suffered by actual victims. See Contorinis, 743 F.3d at 307.

²¹See SEC v. First City Fin. Corp., 890 F.2d 1215, 1231 (D.C. Cir. 1989) ("Since disgorgement primarily serves to prevent unjust enrichment, the court may exercise its equitable power only over property that is causally related to the wrongdoing. The remedy may well be a key to the SEC's efforts to deter others from violating the securities laws, but disgorgement may not be used punitively.").

²²See SEC v. Manor Nursing Centers, 458 F.2d 1082, 1104 (2d Cir. 1972).

²³SEC v. Rosenthal, 426 Fed. App'x 1, 3 (2d Cir. 2011) ("Imposing such a tracing requirement would allow a[ ] . . . defendant to escape disgorgement by spending down illicit gains while protecting legitimately obtained assets or, as was the case here, by commingling and transferring such profits.").

²⁴SEC v. DiBella, 587 F.3d 553, 572 (2d Cir. 2009).

²⁵Id. at 559 (quotations omitted).

²⁶Id. at 572 (emphasis added).

²⁷Id.

²⁸Id.

²⁹SEC v. Razmilovic, 822 F. Supp. 2d 234, 257 (E.D.N.Y. 2011), aff'd in relevant part by Razmilovic, 738 F.3d at 32-33.

³⁰Id. at 255 (emphasis added).

³¹Razmilovic, 738 F.3d at 31 (quoting SEC v. Lorin, 76 F.3d 458, 462 (2d Cir. 1996)).

³²SEC v. Warde, 151 F.3d 42, 50 (2d Cir. 1998) (citing SEC v. Bilzerian, 29 F.3d 689, 697 (D.C. Cir. 1994) ("Bilzerian, however, bears the burden of establishing that the price increases that occurred during his ownership of the stocks were attributable to market forces rather than to his violations.")).

³³Contorinis, 743 F.3d at 305 (quoting First Jersey, 101 F.3d at 1475).

³⁴See First Jersey, 101 F.3d at 1474-75.

³⁵SEC v. Taber, No. 13 Misc. 282, 2013 WL 6334375, at *2 (S.D.N.Y. Dec. 4, 2013) (quotations omitted).

³⁶Id. (quotations omitted).

³⁷Universal Exp., 646 F. Supp. 2d at 563 (citing First Jersey, 101 F.3d at 1475).

³⁸Id.

³⁹SEC v. Credit Bancorp, Ltd., No. 99 Civ. 11395, 2011 WL 666158, at *3 (S.D.N.Y. Feb. 14, 2011).

⁴⁰First Jersey, 101 F.3d at 1476 (quotations omitted).

⁴¹See 15 U.S.C. § 77t(d); 15 U.S.C. § 78u(d)(3).

⁴² 15 U.S.C. § 77t(d)(2)(B); 15 U.S.C. § 78u(d)(3)(B)(ii).

⁴³ 15 U.S.C. § 77t(d)(2)(B); 15 U.S.C. § 78u(d)(3)(B)(ii). Pursuant to the Debt Collection Improvement Act of 1996, the SEC has adopted rules that adjust the maximum penalty pursuant to these provisions for inflation. See 17 C.F.R. § 201.1002, Subpt. E, Tbl. II (setting out maximum penalty during 2001-2005, the time period applicable here).

⁴⁴SEC v. Tourre, No. 10 Civ. 3229, 2014 WL 969442, at *11 (S.D.N.Y. Mar. 12, 2014) (quotations omitted) (citing Pentagon Capital, 725 F.3d at 288 n.7 ("Although we vacate the civil penalty award, we find no error in the district court's methodology for calculating the maximum penalty by counting each late trade as a separate violation.")).

⁴⁵SEC v. Amerindo Inv. Advisors, Inc., No. 05 Civ. 5231, 2014 WL 2112032, at *11 (S.D.N.Y. May 6, 2014) (citing Gabelli v. SEC, 133 S. Ct. 1216, 1220-21 (2013)).

⁴⁶Razmilovic, 738 F.3d at 38 (quoting SEC v. Kern, 425 F.3d 143, 153 (2d Cir. 2005)).

⁴⁷SEC v. Opulentica, 479 F. Supp. 2d 319, 331 (S.D.N.Y. 2007) (quoting SEC v. Moran, 944 F. Supp. 286, 296-97 (S.D.N.Y. 1996)).

⁴⁸Id.

⁴⁹See 15 U.S.C. § 77t(b); 15 U.S.C. §§ 78u(d)(e), 78u-1.

⁵⁰First Jersey, 101 F.3d at 1477 (quoting CFTC v. American Bd. of Trade, Inc., 803 F.2d 1242, 1250-51 (2d Cir. 1986)).

⁵¹Commonwealth Chem. Sec., 574 F.2d at 100.

⁵²Kaplan v. C.I.R., 107 T.C.M. (CCH) 1226, 2014 WL 988465, at *7 (Mar. 13, 2014).

⁵³Gould v. C.I.R., 139 T.C. 418, 437 (2012) (quotations omitted).

⁵⁴Resolution Trust Corp. v. MacKenzie, 60 F.3d 972, 976-77 (2d Cir. 1995).

⁵⁵Schulz v. C.I.R., 686 F.2d 490, 495 (7th Cir. 1982).

⁵⁶ 26 U.S.C. § 671.

⁵⁷Id. § 674(a). Section 672(a) defines adverse party as "any person having a substantial beneficial interest in the trust which would be adversely affected by the exercise or nonexercise of the power which he possesses respecting the trust."

⁵⁸ 26 C.F.R. § 1.674(a)-1.

⁵⁹ 26 U.S.C. § 674(c).

⁶⁰United States v. Ratfield, No. 01 Civ. 8816, 2004 WL 3174420, at *15 (S.D. Fla. Nov. 30, 2004).

⁶¹ 26 C.F.R § 1.674(d)-2.

⁶² 26 U.S.C. § 674(c).

⁶³ 26 U.S.C § 679(a)(1)-(2).

⁶⁴Gudmundsson v. United States, 634 F.3d 212, 221 (2d Cir. 2011) (quoting United States v. Cartwright, 411 U.S. 546, 551 (1973)). Accord 26 C.F.R. § 1.679-4(b)(1) ("For purposes of this section, a transfer is for fair market value only to the extent of the value of property received from the trust, services rendered by the trust, or the right to use property of the trust. For example, rents, royalties, interest, and compensation paid to a trust are transfers for fair market value only to the extent that the payments reflect an arm's length price for the use of the property of, or for the services rendered by, the trust."). Under the pertinent regulations, the transferor is taxable to the extent the exchange exceeds the fair market value of the property received. See id. at (b)(2).

⁶⁵ 26 U.S.C. § 679(c) (emphasis added).

⁶⁶Id.

⁶⁷Altria Group, Inc. v. United States, 658 F.3d 276, 284 (2d Cir. 2011) (quoting Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934)).

⁶⁸Close v. C.I.R., 107 TCM (CCH) 1124, 2014 WL 521039, at *11 (Feb. 10, 2014) (citing Markosian v. C.I.R., 73 T.C. 1235, 1243-44 (1980)).

⁶⁹Id. (quotations omitted).

⁷⁰Bruce v. C.I.R., T.C.M. (CCH) 2014-178, 2014 WL 4336234, at *14 (Sept. 2, 2014).

⁷¹See, e.g., United States v. Buttorff, 761 F.2d 1056, 1062 (5th Cir. 1985) (concluding that trusts where the grantor has only "technically" complied with the statutory provisions have "frequently been recognized [as] mere shams, wholly lacking in any real substance and thus without any effect whatever for federal tax purposes"); Zmuda v. C.I.R., 731 F.3d 1417, 1421 (9th Cir. 1984) ("[T]he economic substance formula may be used to determine whether . . . a trust is a grantor trust for tax purposes") (citing Hanson v. C.I.R., 696 F.2d 1232, 1234 (9th Cir. 1983)); Schulz, 686 F.2d at 495 ("[D]espite efforts to skirt the grantor trust provisions by careful draftsmanship, these trusts in substance, if not in form, violate the statute."); Close, 2014 WL 521039, at *12 (finding that the IRS's theory that a grantor trust exists because the taxpayer has "unfettered access" to its assets is "indistinguishable from [a] sham trust theory").

⁷²See Ratfield, 2004 WL 3174420, at *15-16 ("If the trusts were not shams, they were grantor trusts. . . . Because the trustees of Ratfield's 'pure' trusts are not really independent, the trusts violated the grantor trust provisions in substance, if not in form.").

⁷³See Stipulation of Undisputed Facts ("Stip. Facts") ¶¶ 20-46.

⁷⁴See id. ¶¶ 49-51.

⁷⁵See Trial Transcript ("Trial Tr.") at 96 (opening statement of Stephen Susman, counsel for defense) ("We don't dispute that the trustees followed the recommendations. Yes, indeed, they did, most of the time for sure, and almost always . . . when it came to the four securities that were in companies that the Wylys were more familiar with than anyone in the world.").

⁷⁶ Sam and Charles Wyly were co-founders of Sterling Software and served on its Board of Directors from 1981 and 1984, respectively, until its acquisition by Computer Associates in 2000. The Wylys served on the board of directors of Michaels Stores from 1984 until its acquisition by a consortium of private equity firms in 2006. The Wylys served on the board of Sterling Commerce, a spin-off of Sterling Software, from 1985 until its acquisition by SBC Communications in 2000. Sam and Charles Wyly became directors for Scottish Re in October 1998 and served through March and November 2000, respectively. See Stip. Facts ¶¶ 4-11.

⁷⁷Id. ¶ 59.

⁷⁸See Attachment B to Stip. Facts ("IOM Issuer Transactions") (charts detailing the IOM trusts' transactions in the Issuers' stock during the relevant time period).

⁷⁹See Special Verdict Form.

⁸⁰See Trial Tr. at 157-167 (Robertson); Plaintiff's Exhibit ("PX") 8 (6/12/91 memorandum from Robertson to Sam Wyly, Charles Wyly, Evan Wyly, Sam Wyly's son, French, and Ethel Ketter, in-house CPA for the Wyly family office, discussing Tedder's seminar on "asset protection and tax deferral").

⁸¹See Trial Tr. at 168 (Robertson) and 1717-1718 (French).

⁸²See id. at 1718 (French).

⁸³Id.

⁸⁴Id. at 1719 (French).

⁸⁵ PX 13 (2/28/92 Tedder tax opinion letter), at 10.

⁸⁶See, e.g., PX 9 (11/11/91 memorandum from French to Sam Wyly) (discussing tax benefits of foreign trusts, grantor trusts, and non-grantor trusts).

⁸⁷See Trial Tr. at 1720 (French).

⁸⁸ 3/13/14 Admissions of Michael French, Annex A to 3/20/14 Final Consent Judgment as to Defendant Michael French (Dkt. No. 279) ¶ 9. Accord Trial Tr. at 1720 (French).

⁸⁹See Defendants' Proposed Findings of Fact ¶ 2.

⁹⁰ Trial Tr. at 1884 (Sam Wyly).

⁹¹See id. at 2185 (Sam Wyly) ("We took steps to avoid control, and those are steps to create the appearance of avoiding control. It's reality and it's appearance. You want the appearance to match the reality.") Accord PX 890 (11/3/00 email from Robertson to Evan Wyly) ("Remember that it is critical from a U.S. tax standpoint that there is no appearance that the Wyly's [sic] are in control of the trusts or the protectors.").

⁹²See, e.g., Defendants' Exhibit ("DX") 156 (12/26/96 Michaels Stores press release announcing that Michaels sold options to purchase two million unregistered shares to "separate entities owned by independent trusts of which Wyly family members are beneficiaries").

⁹³See Trial Tr. at 246-247 (Robertson) (discussing tracking ownership of stock among trust management companies, transferring stock between companies, and hiring new trust management companies to avoid any single company owning more than five percent of the Issuer which triggers mandatory reporting). Accord PX 241 (2/20/96 file note taken by David Harris, an IOM trustee, memorializing meeting between Harris, French and Robertson) ("One of the reasons they have a variety of offshore trusts is that holdings in Sterling Software or [Sterling Commerce] held by a trust company for various trusts . . . are amalgamated for SEC purposes and any trust company holding an aggregate of more than 5% of any one class of shares in a company then has certain fairly onerous filing requirements with the SEC. [French and Robertson] confirmed that they were always aware of this as far as the various Wyly entities were concerned. . . .").

⁹⁴ Trial Tr. at 1884-1885 (Sam Wyly).

⁹⁵See PX 1101 (2/26/02 email from Keeley Hennington, tax director and, starting in 2000, CFO of the Wyly family office, to Boucher, attaching Hennington's note to Sam Wyly) ("The trusts are record owners of the shares on C[omputer] A[ssociates]' books. If it is represented [that] there are $2.9 shares [sic], I think it is likely CA may say we show the Wyly's [sic] only own 1.5M options and again the difference would need to be explained. . . . Our friendly IRS agent is still looming around and although he has verbally agreed not to look further at any foreign entities or trusts, I would not want to give him any fresh ammunition.").

⁹⁶ The Wylys, of course, could have had numerous other reasons for wanting to minimize SEC filings, including transaction costs and potentially negative market reaction to insiders selling shares.

⁹⁷See Trial Tr. at 169 (Robertson). The 1992 Trusts relevant to the remedies phase are: 1) the Bulldog Non-Grantor Trust; 2) Lake Providence International Trust; 3) the Delhi International Trust; 4) the Pitkin Non-Grantor Trust; and 5) the Castle Creek International Trust. See Add. Stip. Facts ¶ 7. In 1995, the Bulldog Trust settled the Plaquemines Trust, which had a class of beneficiaries including Sam Wyly's children. These trusts are referred to as the "Bulldog Trusts" for purposes of this Opinion and Order. The terminology was coined by defendants' expert, Professor Robert Danforth, and has been adopted by the parties in their briefing and argument.

⁹⁸See, e.g., DX 257 (Trust Agreement of the Bulldog Non-Grantor Trust) ¶ 1(a)(ii).

⁹⁹Id. ¶ 4.2(b).

¹⁰⁰See id. ¶ 5.2(a).

¹⁰¹ 9/3/12 Deposition Testimony of Charles Lubar, partner at Morgan Lewis ("Lubar Dep."), at 13.

¹⁰² PX 83 (7/29/93 memorandum from Lisa Starczewski, attorney at Morgan Lewis, to file), at 2-3.

¹⁰³See Lubar Dep. at 18.

¹⁰⁴Id. at 27.

¹⁰⁵Id. Accord PX 90 at 1 (2/15/94 memorandum from Lubar to French concluding that such a trust should maintain tax-free status, assuming that the foreign grantor establishes the trust for the Wylys' benefit "as an entirely gratuitous act" and "has not previously and will not in the future receive any consideration, reimbursement, or other benefit for, or in respect of, this act, directly or indirectly.").

¹⁰⁶ PX 90 at 2.

¹⁰⁷ The 1994/1995 trusts relevant to this Opinion and Order are: 1) the Bessie Trust; 2) the La Fourche Trust; 3) the Red Mountain Trust; and 4) the Tyler Trust. See Add. Stip. Facts ¶ 7. These trusts will be referred to as the "Bessie Trusts," as per Professor Danforth's grouping.

¹⁰⁸See DX 271 (deed of settlement for the Bessie Trust); PX 9017 (deed of settlement for the Tyler Trust).

¹⁰⁹ PX 209 (11/26/95 fax from Buchanan to French).

¹¹⁰See PX 208 (11/21/95 fax from Robertson to Boucher).

¹¹¹ PX 157 and 158 (7/18/95 letters from Cairns to Sam and Charles Wyly).

¹¹²See 7/18/12 Deposition of Shaun Cairns, at 43-44.

¹¹³See id. at 46-48, 56-57.

¹¹⁴See Attachment A to Stip. Facts ("IOM Trustees"). Cairns's company, Wychwood Trust Ltd. served, at various points, as the trustee of the Delhi International, La Fourche, Plaquemines, and Red Mountain Trusts.

¹¹⁵See Trial Tr. at 4353-4354 (closing statement of Mark Hatch-Miller, counsel for defendants).

¹¹⁶ PX 209 (11/26/95 fax from Buchanan to French).

¹¹⁷Id.

¹¹⁸ Defendants cite Kanter v. C.I.R., 590 F.2d 410, 424 (7th Cir. 2009), in support of their argument that Cairns should be considered the grantor of the La Fourche and Red Mountain Trusts. In that case, the court found that the taxpayer's mother could be considered the grantor even though she only contributed $100 to trusts established for the benefit of her son and his children that eventually grew to be worth millions of dollars due to other contributions. But the case here is plainly different. Cairns is not a friend, relative, or close business associate of the Wylys. Cairns's transfer at the behest of Buchanan, directly preceding his appointment as trustee of several Wyly trusts, is the definition of non-gratuitous.

¹¹⁹See Attachment A to Stip. Facts ("Isle of Man Trustees").

¹²⁰See Trial Tr. at 1345-1347 (Hennington); PX 990 (10/3/01 email from Hennington to Boucher).

¹²¹ PX 1152 (6/13/02 email chain between Hennington and Boucher). Accord Trial Tr. at 1332 (Hennington).

¹²² PX 544 (9/29/98 file notes of Sue Major, IOM trustee, memorializing telephone conversations with Boucher on 9/28/98 and 9/29/98).

¹²³Id. Accord Trial Tr. at 1107-1109 (Boucher).

¹²⁴See, e.g., Trial Tr. at 1360-1361 (Hennington) (testifying about the trustees purchasing real estate in Dallas and Aspen for use by the Wylys); PX 575 (4/21/99 fax from Robertson to Boucher) ("As in the past, the protectorate committee recommends that Tyler Trust consider the purchase of collectibles and artwork. I am attaching invoices from Marguerite Theresa Green and Associates totalling $224,287.26. . . . If possible, could these funds be wired AS SOON AS POSSIBLE since vendors need to be paid immediately.").

¹²⁵ Stip. Facts. ¶ 60.

¹²⁶See id. ¶¶ 62-64. The Wylys also sold options to the trusts. See id. ¶ 61 (one million Sterling Software options sold in December 1992), and ¶ 65 (2,625,000 Sterling Software options and 712,500 Sterling Commerce options sold in September 1999).

¹²⁷See PX 412 (6/4/97 memo from Lubar to Ellen K. Harrison and B. John Williams, lawyers at Morgan Lewis, discussing upcoming meeting with French to discuss foreign annuities).

¹²⁸ Lubar Dep. at 39.

¹²⁹Id. at 41.

¹³⁰See id. at 56.

¹³¹See 3/29/11 Deposition of Jeannette Meier, general counsel of Sterling Software ("Meier Dep."), at 85-86.

¹³²See PX 13 (4/9/92 letters from Tedder to Sterling Software and Michaels Stores, attaching 2/28/92 Tedder opinion letter regarding the private annuity transaction), at 5 ("Pursuant to the general federal income tax treatment of property exchanged for a private annuity the sale of property to the corporation in exchange for the receipt of a private annuity is not a taxable event in the year 1992.").

¹³³ Meier Dep. at 87.

¹³⁴Id. at 95.

¹³⁵See PX 438 (7/18/97 memorandum from Beasley to Michaels Stores); 3/7/11 Deposition of Mark Beasley, at 131-132.

¹³⁶ PX 9022 and PX 9023 (1/11/01 letters from John J. Stephens, vice-president of taxes for SBC, to Sam and Charles Wyly).

¹³⁷Id. The total amount represents the cash value of Sam Wyly's options ($46,575,000) and Charles Wyly's options ($27,337,500).

¹³⁸See PX 9001 (1/23/01 email from Robertson to Boucher) ("If it is in opinon [sic] form from an attorney, SBC is more likely to put the document in their tax file and accept the position. I'd definitely have Rodney issue a memo and I'd consider putting it in opinion form. There's toooooooo much money at stake here."). See also PX 9024 (1/25/01 email from Boucher to Owens) ("I also told the people at SBC to let them know that something will be coming to explain why no 1099 is necessary. I did not want to run the risk that they go ahead and file a 1099 before the 31st.") (marks omitted).

¹³⁹ PX 9025 (1/26/01 letter from Owens to Stephens).

¹⁴⁰See PX 9026 (1/29/01 email from Hennington to Robertson and Boucher) ("This is getting to be a bigger project because SBC wants a schedule of the annuity payouts because they are entitled to a deduction at the time payments are made under the annuities.").

¹⁴¹See PX 9031 (2/07/01 memorandum from French to file regarding Sterling option transfers); PX 9034 (memorandum from Hennington to SBC).

¹⁴²See 7/25/14 Joint Pre-Trial Order ¶ 5(c).

¹⁴³See Trial Tr. at 3403 (Hennington).

¹⁴⁴See PX 1224 (2/5/03 email from Boucher to Hennington, attaching draft email to Lubar for a meeting agenda to discuss the IOM trusts and private annuities).

¹⁴⁵See Lubar Dep. at 65-67. Accord PX 1236 (3/14/03 memorandum from Lubar and Sholom Y. Sittner, lawyer at Morgan Lewis, to File).

¹⁴⁶ PX 1239 (3/25/03 email from Joan Ingram, lawyer at Morgan Lewis, to Boucher, attaching attorney notes on a 3/17/03 meeting with Boucher, Hennington, Lubar, and Ingram).

¹⁴⁷ PX 1255 (7/2/03 memorandum from Hennington and Boucher).

¹⁴⁸Id.

¹⁴⁹Id.

¹⁵⁰ PX 1259 at 1 (8/28/03 fax from Miriam L. Fisher, attorney at Hogan & Hartson, to Hennington, attaching attorney notes from 8/13/03 meeting with the IRS).

¹⁵¹Id. at 5.

¹⁵²Id. at 6.

¹⁵³ PX 1260 (8/29/03 memorandum from Boucher and Hennington to Sam Wyly, Charles Wyly, Evan Wyly, and Donald Miller).

¹⁵⁴See PX 9082 (2/2/04 notice of audit sent to Charles and Caroline Wyly).

¹⁵⁵ PX 1306 (2/3/04 email from Hennington to Boucher and Pulman).

¹⁵⁶ PX 1307 (2/4/04 memorandum from Christian G. Newsom, attorney at Meadow Owens, to Pulman), at 1.

¹⁵⁷See, e.g., PX 9085 (5/18/04 IDR #18 to Charles Wyly), PX 9106 (8/3/04 IDR #39 to Charles Wyly); PX 9003 (8/3/04 IDR #41 to Sam Wyly).

¹⁵⁸ PX 9003 (8/3/04 IDR #41 to Sam Wyly) ("The Michaels Stores, Inc. 10K filed with the SEC on [May 2, 1997] contained the following statement: 'Subsequent to year end, options to purchase 2,000,000 shares of the Comapny's Common Stock were exercised . . . through private transactions with entities owned by independent trusts of which Wyly family members are beneficiaries. . . .' Please provide the following [information] for the independent trust(s). . . .").

¹⁵⁹ PX 1373 (10/22/04 memorandum from David M. Kniffen, attorney at Meadows Owens, to File, memorializing 10/21/04 meeting with IRS).

¹⁶⁰See id.

¹⁶¹ DX 48 (3/29/96 Michaels Stores press release). Accord Stip. Facts ¶¶ 72-74.

¹⁶²See IOM Issuer Transactions, Exs. 12A and 12B.

¹⁶³ DX 56 (12/26/96 Michaels Stores press release). Accord Stip. Facts ¶¶ 75-76. The options were purchased on December 23, 1996 for $.50 per share, and the exercise price was $10.50 per share.

¹⁶⁴See DX 53 ("Michaels Stores Turns to Chairman Again for Infusion of Cash," Wall Street Journal (Jan. 7, 1997)) ("Chairman Sam Wyly said his cash infusion is intended to bolster investor confidence in the company and give Michaels more financial flexibility at a troubled time.").

¹⁶⁵See DX 371 (historical trading data for Michaels Stores from the Center for Research in Security Prices).

¹⁶⁶See IOM Issuer Transactions, Exs. 12A, 12B, 13A, and 13B.

¹⁶⁷See DX 371 (historical trading data for Michaels Stores from the Center for Research in Security Prices).

¹⁶⁸See IOM Issuer Transactions, Exs. 12A, 12B, 13A, and 13B.

¹⁶⁹See Stip. Facts ¶ 79.

¹⁷⁰See IOM Issuer Transactions, Exs. 12A, 12B, 13A, and 13B.

¹⁷¹See Stip. Facts ¶¶ 77-78.

¹⁷²See Trial Tr. at 4036-4037 (McConnell).

¹⁷³See id. at 4037 (McConnell).

¹⁷⁴Id. at 4038-4039 (McConnell).

¹⁷⁵See id. at 4044-4056 (McConnell).

¹⁷⁶See DX 1166 ("Total Estimated Economic Benefit Related to the Sale of Unregistered Shares").

¹⁷⁷See PX 7002 (summary chart showing Sam and Charles Wylys' ownership of common stock in Michaels Stores). This calculation includes the shares held by the IOM trusts.

¹⁷⁸See PX 4139 (10/23/96 Michaels Stores Schedule 14A Proxy Statement. Michaels Stores' Board of Directors at this time consisted of Sam Wyly, Charles Wyly, Evan Wyly, French, Miller, Richard Hanlon and Jay Taylor.

¹⁷⁹ Trial Tr. at 4162 (McConnell).

¹⁸⁰See DX 1072 (Market-Adjusted Returns Following Onshore Net Sales Disclosures).

¹⁸¹ During pre-trial proceedings, I excluded defendants' expert, Erik Sirri, from testifying about the purported non-impact of the Wylys' failures to disclose based on an analysis of onshore disclosures. I excluded Sirri's testimony because "offshore sales exceeded domestic sales by a ratio of 20 to 1" and "the comparison between a handful of disclosed domestic transactions and the average of far more frequent and sizeable undisclosed offshore transactions does not take into account the potential outlier nature of the domestic transactions and blurs together the characteristics of the much more prolific offshore transactions." Transcript of 2/3/14 Conference, at 30, 32. These identical concerns apply here.

¹⁸²See Trial Tr. at 4060-4063 (McConnell).

¹⁸³See PX 7002.

¹⁸⁴See Trial Tr. at 4419 (closing statement of Bridget Fitzpatrick, counsel for the SEC).

¹⁸⁵See DX 371 (historical trading data for Michaels Stores from the Center for Research in Security Prices).

¹⁸⁶See id.

¹⁸⁷ The discount is calculated by taking the difference between the per share price on the close of trading on April 4 ($15.35) and the per share purchase price set by the private placement agreement ($12.50) and dividing it by the purchase price (again, $12.50).

¹⁸⁸ Mukesh Bajaj et al., Firm Value and Marketability Discounts, 27 Journal of Corporate Law 89, 97 (2001) (collecting and summarizing studies).

¹⁸⁹SEC v. Wyly, No. 10 Civ. 5760, 2013 WL 2951960, at *1 (S.D.N.Y. June 13, 2013) (quotations omitted).

¹⁹⁰ 26 U.S.C. § 6301.

¹⁹¹Id. § 7401.

¹⁹²Wyly, 2013 WL 2951960, at *1 (emphasis in original).

¹⁹³United States v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213, 224 (1996) (quotation omitted).

¹⁹⁴See 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)).

¹⁹⁵Helmsley, 941 F.2d at 102.

¹⁹⁶ Def. Mem. at 3.

¹⁹⁷Contorinis, 743 F.3d at 307.

¹⁹⁸SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir.1987).

¹⁹⁹See Razmilovic, 738 F.3d at 31.

²⁰⁰See SEC v. Patel, 61 F.3d 137, 140 (2d Cir. 1995).

²⁰¹SEC v. World Gambling Corp., 555 F. Supp. 930, 934 (S.D.N.Y. 1983).

²⁰² Def. Mem. at 22-23.

²⁰³ 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).

²⁰⁴See 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.").

²⁰⁵ 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.

²⁰⁶See 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.").

²⁰⁷ Def. Resp. to U.S. at 21.

²⁰⁸ 26 U.S.C. § 674(a) (emphasis added).

²⁰⁹ Def. Mem. at 8 (quoting Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates and Gifts § 80.6.1).

²¹⁰Id. 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).").

²¹¹ Def. Mem. at 9.

²¹² 26 C.F.R. § 1.674(c)-1.

²¹³Id.

²¹⁴See 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").

²¹⁵Estate of Goodwyn v. C.I.R., T.C.M. 1976-238, 1976 WL 3423 (July 29, 1976).

²¹⁶PPL Corp. v. C.I.R., 133 S.Ct. 1897, 1905 (2013) (quoting CIR v. Southwest Exploration Co., 350 U.S. 308, 315 (1956)).

²¹⁷ Danforth, et al., Federal Income Taxation of Estates and Trusts § 9.04[3] [a].

²¹⁸ 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").

²¹⁹ That being said, it would be naive to assume that the Wylys did not, at least occasionally, take advantage of their ability to trade, in secret, on the informational advantages they had due to positions of influence in the Issuer companies, even if that trading did not rise to the level of market distortion, manipulation, or insider trading.

²²⁰ Def. Mem. at 20.

²²¹Id. at 18-19.

²²²SEC v. Banner Fund Intern., 211 F.3d 602, 617 (D.C. Cir. 2000) (emphasis added).

²²³See 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.").

²²⁴SEC v. Ralston Purina, 346 U.S. 119, 124 (1953).

²²⁵See, e.g., SEC v. Universal Exp., Inc., 438 Fed App'x 23, 26 (2d Cir. 2011); SEC v. Cavanagh, No. 98 Civ. 1818, 2004 WL 1594818, at *30 (S.D.N.Y. Jul. 16, 2004), aff'd by Cavanagh, 445 F.3d at 116-17.

²²⁶See, e.g., SEC v. Rosenfeld, No. 97 Civ. 1467, 2001 WL 118612, at *1 (S.D.N.Y. Jan. 9, 2001) (defendants engaged "in a fraudulent scheme to falsely inflate the value of common stock and to evade the registration requirements of the federal securities laws"); SEC v. East Delta Resources Corp., No. 10 Civ. 310, 2012 WL 3903478 (E.D.N.Y. Aug. 31, 2012) (defendants sold unregistered shares of a "penny stock company that purported to own and/or operate gold and other mineral mining properties in China").

²²⁷See 8/27/14 Letter from Fitzpatrick to the Court, at 2 n.3 [Dkt. No. 455].

²²⁸ Def. Mem. at 29.

²²⁹Id.

²³⁰See supra n. 188.

²³¹ 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.

²³² SEC Mem. at 30.

²³³ Defendants' Proposed Conclusions of Law ¶¶ 96, 98.

²³⁴Contorinis, 743 F.3d at 305 (quoting First Jersey, 101 F.3d at 1475).

²³⁵Moran, 944 F. Supp. at 295.

²³⁶See SEC v. Inorganic Recycling Corp., No. 99 Civ. 10159, 2002 WL 1968341, at *2 (S.D.N.Y. Aug. 23, 2002) ("The fact that swindlers have run through the proceeds of the fraud and are now insolvent should not prevent the imposition of a remedy, since defendants may subsequently acquire the means to satisfy the judgment.") (quotation omitted)).

²³⁷See Trial Tr. at 4292-4293 (Fitzpatrick) (identifying cases in the Second and Third Circuits upholding prejudgment interest awards for periods longer than ten years).

²³⁸See Gabelli, 133 S. Ct. at 1222 ("Unlike the private party who has no reason to suspect fraud, the SEC's very purpose is to root it out, and it has many legal tools at hand to aid in that pursuit.")

²³⁹ While the Second Circuit has approved of using the IRS underpayment rate in SEC disgorgement cases, see First Jersey, 101 F.3d at 1476-77, this Court has the discretion to select the rate it sees fit. Because this is not an action for underpayment of taxes, I decline to adopt that rate for the entire period.

²⁴⁰ SEC Mem. at 31.

²⁴¹See, e.g., SEC v. Credit Bancorp, Ltd., 738 F. Supp. 2d 376, 391 (S.D.N.Y. 2010) ("[T]he Court finds that the penalties of disgorgement, criminal restitution, incarceration, and injunction against future violations imposed on Rittweger are sufficient to deter future illegal conduct. A further penalty at this time is inappropriate.").

²⁴² Although the SEC must recalculate prejudgment interest, according to my rough estimate, the final disgorgement award, including prejudgment interest will be between $300 and $400 million dollars. This single award is equivalent to approximately ten percent of the total penalties and disgorgement ordered in SEC enforcement cases nationwide last year. FY 2013 SEC Financial Report, available at http://www.sec.gov/about/secpar/secafr2013.pdf, at 18 ("In the fiscal year, total penalties and disgorgement ordered increased to $3.4 billion, up from $3.1 billion in the prior fiscal year.").

²⁴³ SEC Proposed Conclusions of Law ¶ 92.

²⁴⁴ SEC Mem. at 35.

²⁴⁵ Def. Mem. at 25.

²⁴⁶Tourre, 2014 WL 969442, at *15 (quoting SEC v. Goble, 682 F.3d 934, 949-52 (11th Cir. 2012)).

²⁴⁷See SEC Mem. at 34-35. See PX 4 (SEC v. Samuel E. Wyly, Civ. Action No. 79. 3275, Lit. Rel. No. 8943 (D.D.C., Dec. 6, 1979)).

²⁴⁸ Joint and several liability is unwarranted for both measures of disgorgement because these gains are "reasonably apportioned" between the two defendants. Universal Exp., 646 F. Supp. 2d at 563.

²⁴⁹See SEC v. Wyly, No. 10 Civ. 5760, 2014 WL 3739415 (S.D.N.Y. July 19, 2014).

²⁵⁰See Dkt. No. 456.

²⁵¹See 9/12/14 Expert Report of Dr. Chyhe K. Becker.

²⁵²See 9/5/14 Defendants' Brief in Opposition to the SEC's Request to Hold the Record Open [Dkt. No. 458]; 9/23/14 Letter from Susman to the Court [Dkt. No. 474].

²⁵³ Becker Rep. ¶ 2. Dr. Becker's other two measures are unacceptable for the following reasons. The first measure approximates the Wylys' gains in excess of an average buy and hold investor assuming that the Wylys exercised their options before transferring the securities to the IOM trusts. This counterfactual is belied by the facts of the case and would thus be an inaccurate measure of unlawful gains. The second measure calculates disgorgement based on the economic value of the Wylys' non-disclosure. This second measure is, in sum and substance, a rebuttal to Professor McConnell's report and methodology, much of which has already been discussed and rejected here. Furthermore, this attack on Professor McConnell's June 19, 2014 report is untimely, coming a month after the conclusion of the remedies trial at which he testified. If defendants wish to use McConnell as their rebuttal expert to Dr. Becker, the SEC may elicit its criticisms in cross-examination as it did during the August trial.

²⁵⁴ At least one informational advantage the Wylys undisputedly possessed was knowledge of their own large volume transactions in the Issuer securities. The SEC may also argue that the Wylys' systematic failure to disclose their trading concealed the informational advantages they possessed by virtue of being controlling insiders in the Issuer companies.