SEC v. Miller: Second Circuit Addresses a Temporary Asset Freeze and the “Money Judgment” Exception Under § 362

The legal saga of the Wyly brothers continues.

Born in rural Louisiana during the Great Depression, Samuel Wyly and his older brother Charles, Jr., built a fortune from a computer company and later from steakhouses and Michael’s, an arts-and-crafts retail chain. In 2010, however, the U.S. Securities and Exchange Commission (SEC) brought a civil enforcement action against the Wylys, alleging that they participated in an elaborate international securities fraud scheme. A year later, Charles was killed in an auto accident. In 2014, following a six-week trial, a jury in New York found Samuel Wyly and the estate of Charles liable for multiple claims of securities fraud. The SEC sought $300 million in disgorgement payments and asked the U.S. District Court for the Southern District of New York to impose a freeze to prevent the dissipation of assets.

But before the district court could act, Samuel Wyly and Charles’s widow filed for chapter 11 bankruptcy protection in Texas. They argued that the district court was prohibited from entering the asset freeze because it violated the automatic stay requirements of § 362 of the Bankruptcy Code. The district court rejected this argument and entered a temporary freeze order against 16 Wyly family members and other defendants, a stop-gap measure until the debtors filed bankruptcy schedules and the bankruptcy court could take control of far-flung assets. The defendants appealed.

In December 2015, the U.S. Court of Appeals for the Second Circuit in SEC v. Miller upheld the legality of the district court order as it applied to Samuel Wyly, the estate of Charles and several others.[1] But the Second Circuit said it was unable to determine on the record whether sufficient evidence existed to support the imposition of the freeze order against seven other defendants, and it therefore remanded the dispute to the district court to obtain more facts.

The issue before the Second Circuit was the scope of the “governmental unit” exemption of § 362.[2] Under § 362, all legal proceedings against a debtor are stayed, including “any act to obtain possession of property of the [bankruptcy] estate.”[3] But there’s an exception for an action brought by a “governmental unit” to enforce its police and regulatory power, including the enforcement of a judgment other than a money judgment.[4]

The parties in Miller all agreed that the SEC’s civil enforcement action against the Wylys, brought after a six-year long investigation, met the definition of an action by a “governmental unit.” In its complaint, the SEC had alleged that for more than a decade the Wyly brothers had transferred stock options in four publicly traded companies to offshore trusts and subsidiaries in the Isle of Man, a self-governing British Crown dependency in the Irish Sea. According to trial evidence introduced in 2014, the Wylys used the Island of Man trusts to trade in secret without making the requisite disclosures in order to protect their assets from creditors and to avoid taxes on trading profits earned. Some of the proceeds from these transactions flowed not only to the Wylys, but allegedly to other family members not named as defendants in the SEC action.[5]

It was the SEC’s subsequent attempt to collect $300 million in disgorgement payments that triggered the dispute in Miller. The defendants argued that the SEC’s request for an automatic freeze was a preparatory step in collecting on an anticipated monetary award from the Wylys and thus fell within the “money judgment” exception to the “governmental unit” exception. The SEC argued — and the Second Circuit ultimately agreed — that the freeze order was not a money judgment, but rather an order to preserve assets of the bankruptcy estate and to prevent ill-gotten gains from flowing to certain family members or offshore accounts. Thus, the “money judgment” exception did not apply.

 The Second Circuit was clearly concerned about the ability of at least some of the defendants to dissipate and transfer key assets. It noted that the “Wylys initiated bankruptcy proceedings and invoked the automatic stay mere days after the SEC filed its then-pending motion for an asset freeze. The timing speaks loudly for itself.”[6]

In such circumstances, the temporary asset freeze was fully consistent with a policy of preventing a debtor from frustrating necessary governmental functions by seeking refuge in a bankruptcy court, the Second Circuit said.

In its decision, the Second Circuit distinguished SEC v. Brennan, a 2000 opinion that vacated an order directing a defendant to repatriate assets held abroad and deposit them in a court registry.[7] The Second Circuit in Miller concluded that the temporary asset-freeze order was different from the repatriation order in Brennan: It did not transfer assets, but rather preserved the status quo in anticipation of a final judgment. The asset-freeze, the Second Circuit said, “did not enforce a money judgment because, as of the date of issuance of the freeze order, no judgment had yet been entered.”[8]

Meanwhile, the chapter 11 bankruptcy cases of Samuel Wyly and the widow of Charles Wyly are proceeding in Texas. In re Samuel E. Wyly, case 14-35043, and In re Caroline D. Wyly, case 14-35074.