WOLF

POPPER
LLP
2014 Public Safety Employees
Pension & Benefits Conference

The Long and Winding Saga

Of the Wyly Brothers

New Orleans, LA.

October 27, 2014

By
Chet B. Waldman, Esq.
Wolf Popper LLP

The Wyly Brothers Quest To Violate

Every White Collar Crime In The Book

by: Chet B. Waldman

1

Who are the Wyly Brothers?

Brothers Sam and Charles Wyly: inseparable from

childhood

Grew up in rural Lake Providence, in East Carroll

parish, Louisiana
Played H.S. football for Delhi High School on
team that won state championship, along the way
beating their cross-town rivals from Tallulah H.S.
Moved to Texas where they spent 5 decades in
business together
Lived in summer homes in Aspen, Colorado,
Pitkin County, so they could vacation together
2

Southern Charm
Wylys were very proud of their southern
heritage

Maternal great-great-grandfather Edward Sparrow - was a Confederate

Senator who fought with Louisiana
regiments in the Civil War

In Sam Wylys home in Dallas he has a

painting called Moonlight and Magnolias
in which he and his wife #3 are dancing
with him wearing the gray uniform of a
Confederate General.

Republicans to the core

Wyly Business Acumen

Early pioneers in computer software - built

Sterling Software into multi-billion-dollar+
company by buying up competitors, many through
hostile tender offers

Founded Datran, a forerunner to the internet which,

in the early 1970s, got computers talking to each
other through a series of microwave towers

Bought Michaels, a craft-store chain, in 1983 and

built it into a national chain

Opened the Maverick Capital hedge fund in early

1990s - $8 billion in assets

Founded power reseller Green Mountain Energy

prior to power deregulation occurring in Texas
4

All This Success Makes The Wylys Rich:

How Rich?

In 2010 Sam Wyly appeared on Forbes list of the

400 richest Americans with $1 billion net worth

In 2011 Forbes listed Sam as the 393rd richest man

in the world

Active philanthropists providing millions of dollars

to arts groups, colleges, literary programs and
animal shelters
- Theater in Dallas Arts District bears the names of
Charles and his wife

Political Contributions

The Wylys have contributed roughly $10 million to

192 Republican candidates and causes

Sam directed Richard Nixons election effort in the

State of Texas

Personal friends of George H.W. Bush and among

the bigger donors to George W. Bush during his
presidency

Democrats particularly hated the Wylys for various

attack ads:
- Funded TV ads of Swift Boat Veterans for Truth
Group that questioned John Kerrys war record
6

The One Thing The Wylys Hated More

Than Democrats From The North: Taxes!

According to a business acquaintance: Sam Wyly is

the most tax-averse bastard youve ever met

Protecting the money they spent a lifetime earning

became an obsession for the Wylys
- In 1992 they enlisted the advice of tax attorney
David Tedder to help them avoid paying taxes
- Tedder later went to prison on unrelated tax and
money-laundering convictions

- Tedder introduced the Wylys to 2 key tax havens:

The Cayman Islands and the Isle of Man

Tax Haven/Heaven?

Cayman Islands
Vacation resort hotspot
International tax haven
Low taxes
Secret bank accounts allowed

Isle of Man
Located in the middle of the Irish Sea
100 square miles smaller than Dallas
Less than 80,000 people
International tax haven
No estate tax
Highest tax bracket is 20%
10% corporate tax rate

These tax havens cost the U.S. government

hundreds of billions of dollars in tax revenue

Tax Avoidance or Tax Evasion?

How the Wylys got around paying taxes

Between 1992-1996 they created 17 offshore trusts in

the Isle of Man, each of which owned several subsidiaries
(41 dummy corporations)

The trusts were named after places in Louisiana where

Wylys grew up (e.g. East Carroll) or related to their
high-school days (e.g. Delhi and Tallulah) or their
summer homes in Colorado (e.g. Pitkin)

A Wyly-related entity in the Cayman Islands (the Family

Office) conveyed the Wylys investment recommendations to the trustees who always made transactions
based on these recommendations

Tax Avoidance or Tax Evasion?

The Wylys were directors of 4 public companies:

Michaels Stores

Sterling Software

Sterling Commerce

Scottish Re Group
Limited

As part of their compensation, Wylys received stock

options and warrants from the 4 companies

Between 1992-1999, Wylys sold or transferred these stock

options to their offshore entities in return for annuities
that would pay out the value of the securities over time

Between 1995-2005, the 58 trusts and companies

exercised these options, separately acquired options and
stock in all 4 companies, and sold the shares for total
profits calculated to be $487,780,099!

10

Tax Avoidance or Tax Evasion?

For many years, on paper, the Wylys were paupers with the offshore trusts owning their assets, which the Wylys were able
to use on loan. The trusts owned:
4 properties in Aspen, Colorado
100-acre horse farm outside Dallas
$1 million painting of Ben Franklin
$750,000 emerald necklace
$622,000 ruby
Norman Rockwells original Rosie the Riveter painting
purchased for $4.96 million highest price ever paid for a
Rockwell

When Wylys needed cash it usually came in the form of taxexempt loans from the trusts

Such an arrangement would be legal if the trusts were operated

independently of the Wylys. However, if the Wylys directed all
of the investment activity of the trusts and transferred proceeds
into their own bank accounts, that would be illegal

11

The U.S. Government Learns of the Wylys

Offshore Holdings

The offshore entities securities were held in U.S.

brokerage accounts including at Bank of America
(BofA)

In early 2004, BofAs clearing firm flagged the Wylys

offshore accounts. In seeking to comply with antimoney laundering provisions of the PATRIOT
ACT (i.e. know your customer laws), BofA attempted
to learn the underlying beneficiaries of the trusts

The offshore trusts refused to comply, seeking to

keep hidden the Wylys beneficial interest

BofA closed the accounts and reported the offshore

entities to the SEC in November 2004
12

The SEC Files a Lawsuit

For 6 years, mostly while Republicans were in the White House

and controlled the SEC, the government steered clear of the
Wylys. However, 18 months after Barack Obama was elected
and then installed his own SEC Commissioner, the SEC
brought an action against the Wylys

On July 29, 2010, the SEC filed a 78-page Complaint in

the U.S. District Court in Manhattan against the Wylys, their
personal attorney, and their stockbroker

Perhaps an artful and legitimate attempt to avoid a

Texas Court since Washington regulators historically
are not embraced there

Sam Wyly had a previous history with the SEC

In 1979 he was sued by SEC in connection with a bond deal

which was settled without admitting or denying wrongdoing
13

Insider-Transaction Reporting
Requirements

Holdings and every trade in a public companys securities by

an officer or director of that company has to be disclosed on a
Form 4 filing with the SEC

Holdings and every trade by a beneficial owner of greater

than 5% of a public companys stock has to be disclosed by
that owner on a Schedule 13D with the SEC

Purpose: The disclosure scheme requiring insiders to report

beneficial ownership and any changes in that ownership
reflects Congresss judgment that public disclosures of
insiders ownership of, and trading in, company stock
provides valuable information to investors

The very purpose of insider-transaction reporting

requirements . . . is to give investors an idea of the
purchases and sales by insiders which may in turn
indicate their private opinion as to prospects of the
company. [SEC v. Wyly, 788 F. Supp. 2d 92, 123 (S.D.N.Y. 2011)]
14

The SEC Files a Lawsuit

Crux of SECs Allegations: Wylys engaged in a

13- year fraudulent scheme to hold and trade tens of
millions of securities of public companies while they
were the members of the boards of directors of those
companies, without disclosing their ownership and
their trading of those securities. [SEC v. Wyly, 950 F. Supp.
2d 547, 550-51 (S.D.N.Y. 2013)]

2 primary allegations:

1)

The Wylys traded 14 million shares via the offshore

vehicles in violation of rules requiring corporate
insiders owning 5% or more of a company to
disclose their holdings and trades (i.e. failed to
file Form 4s and 13Ds)

2)

Insider Trading
15

Failure to File Form 4s and Schedule 13Ds

The SEC alleged that the Wylys spread their stock

holdings in Sterling Software, Sterling Commerce,
Michaels Stores and Scottish Re among their 50+ offshore
entities. While each entity held a small percentage of
shares in these companies, all the trusts combined held a
significant portion of the companies outstanding shares

E.g. At their peak, the trusts held 36.7% of Michaels

and 33.7% of Sterling Software

Because they did not file 13Ds or Form 4s, the public
did not know of the Wylys significant ownership
interests in these companies

16

The Insider Trading Claim

In September 1999, the Wylys, who led the Boards of

Sterling Software and Sterling Commerce, decided that
they would pursue selling both companies and they
retained Goldman Sachs to evaluate potential buyers

In October 1999, the Wylys engaged in a large stock swap

allowing them, in essence, to buy up millions of shares in
Sterling Software through the offshore trusts. They also
had Sterling Software change its bylaws to increase
payouts to the Wylys if the Company was bought

Negotiations to sell Sterling Software did not begin until

January 2000 and the Company was sold shortly
thereafter allowing the Wylys to reap $31.7 million from
the trades they made in October 1999
17

The Wylys Defenses to the

SEC Action

Most of the facts alleged were not disputed by the

Wylys

Statute of Limitations

Failure to File Ownership Interest Information

Many of the events happened more than a decade

ago

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

the shares in the companies
Reliance on advice of counsel and accountants

Insider Trading

Sale of Sterling Software didnt occur until more than

3 months after Wylys acquired more shares

18

The Death of Charles Wyly

In August 2011, Charles, at age 77, was
killed when he tried to cross a highway in
Aspen, Colo. and an SUV t-boned his
Porsche 911 Targa
5 months later, the SEC won an
unprecedented Court decision to sue
Charles estate: Zombie Litigation. An
executor for his estate was substituted as a
defendant
19

Certain Claims are TimeBarred

SEC can sue for disgorgement of unlawful

profits and add civil penalties on top in
egregious circumstances (e.g. 3X unlawful profits)

On June 6, 2013, the Court found that any

penalty claims for securities violations against
the Wylys arising before February 1, 2001 (i.e.
virtually all of them) were barred by the statute of
limitations. This barred any civil penalties for the
1999 insider trading violations, among other
allegations

The Court, however, held that the SEC still had

claims for disgorgement of illegal trading
profits relating to the insider trading claims.

20

The Jury Verdict

On an in limine motion immediately prior to trial the

Court dismissed the remaining insider trading claim

Trial lasted from March 31 May 7, 2014

Jury returned a verdict against both Wylys on all

nine remaining claims, including securities fraud,
and failure to make various disclosures

Specifically, the jury found that the Wylys had engaged

in fraud over 13 years by failing to disclose
numerous trades which were hidden from investors
in the companies

The Court thereafter set a trial schedule for the

remedies phase of the litigation

21

The Remedy?

The SEC contended that the Wylys derived $553 million in

profits from their unlawful trades

On July 29, 2014, the Court rejected the SECs proposed

disgorgement of profits request, finding it unsupported by
evidence, noting that not all the profits came from the
failures to disclose, as opposed to general market runups and other factors. Court gave the SEC another
chance to prove the amount of profits stemming from the
violations of law

On August 4, 2014, the Court held a remedies hearing

On September 24, 2014, the Court awarded the SEC $187

million plus pre-judgment interest (total payment will be
between $300-$400 million)
22

How Does Insider Trading, Or A Directors Failure To

Disclose Holdings, Impact Your Funds?

1.

Every time someone buys or sells shares on inside information

without disclosing it, the opposite side of the trade is being
deceived and disadvantaged.

2.

E.g., if your funds were selling Sterling Software stock at the end
of 1999 and you did not know that the company was planning to be
sold at a significant premium, a fact known by the Wyly brothers
which they did not disclose while they bought up shares of Sterling
Software, you lost money while they made $ tens of millions.

3.

Investors lose confidence in the stock market when they see

insiders are gaming the system. Less investors means less
liquidity, available capital for companies, etc.

4.

Consequently, the federal securities laws allow disadvantaged

shareholders harmed by insider trading and certain failures to
disclose to sue for their losses against the wrongdoers.

How do you know if your fund may have a legal claim?

A. Portfolio Monitoring
23

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