Someone accused of securities fraud cannot file bankruptcy to bar the Securities and Exchange Commission from freezing assets in district court, according to the Second Circuit.
Sam Wyly, his deceased brother Charles and their alleged violations of securities laws gave the appeals court occasion on Dec. 18 to draw the contours more clearly delineating the demarcation between the automatic stay and the exception in Section 362(b)(4) allowing governmental enforcement of police and regulatory powers. After a six-week trial in federal district court in Manhattan, a jury decided in May 2014 that the brothers violated securities laws by using offshore trusts to trade secretly in the stock of companies for which they served on their boards.
Without a jury, District Judge Shira Scheindlin in New York concluded in September 2014 that some $300 million was a reasonable approximation of disgorgement of the brothers’ ill-gotten gains, measured by the taxes they improperly evaded. The SEC then moved to freeze their assets. While the motion was pending, Sam filed a chapter 11 petition in Dallas in October 2014. Four days later, Caroline Wyly, the widow of Charles, filed a companion chapter 11 petition.
Judge Scheindlin froze Wyly family assets in an opinion in November 2014 in which she concluded that the automatic stay did not apply. While allowing everyone living expenses, she also froze assets of 16 other family members.
On the automatic stay issue, the family appealed and lost in an opinion by Circuit Judge Jose A. Cabranes. Sam did not appeal the decision, nor did Caroline, who had initiated proceedings in Dallas, where the bankruptcy judge ruled that the automatic stay does not preclude an asset freeze.
Judge Cabranes’ opinion focused on the Second Circuit’s 2000 decision in SEC v. Brennan, in which the appeals court found a violation of the automatic stay because the district court had ordered the repatriation of assets following entry of judgment. In that case, the appeals court believed that repatriation was preparatory to collection of a judgment and thus violated the stay.
The Wyly case was different, Judge Cabranes said, because the asset freeze only preserved the status quo and did not “rise to the level of impermissible enforcement of a money judgment.” On statutory and policy grounds, he found that the “pre-judgment asset freeze at issue here thus does not implicate the same concerns as did the post-judgment repatriation and deposit order in Brennan.”
The result turned in significant part on the contours that Judge Scheindlin gave to the asset freeze. In particular, the freeze will dissolve once the assets are under the bankruptcy court’s control. At that point, Judge Cabranes said in a footnote, the “bankruptcy court will continue its work without the involvement of the district court.”
The decision was not a total victory for the SEC. With respect to seven family members, the appeals court reversed and remanded, directing Judge Scheindlin to decide whether there was evidence that they had received ill-gotten gains.
The opinion dealt only with the automatic stay and not with the amount of the asset freeze or whether the Wylys violated securities laws.