Wyly Case History & Summary
The summary examines the inception and development of the Wyly offshore structure over a thirteen year period, from 1992 to 2005, and analyzes key tax, securities, and anti-money laundering issues.
The evidence presented to the Senate Subcommittee showed that Sam and Charles Wyly exercised significant direction over the trust assets and the investment activities of the trusts that were established to benefit their families. The Wylys and their representatives typically conveyed their decisions about trust assets to individuals named in the trust agreements as "trust protectors." These trust protectors, selected by the Wylys, were in constant communication with Wyly family members and their representatives. The trust protectors used a stream of telephone calls, correspondence, faxes, and electronic mail to convey decisions to the trustees of the offshore trusts. The trust protectors typically worded these decisions as "recommendations" to the offshore trustees who, in form under Isle of Man trust law, retained the final decision making authority over trust assets, but in practice carried out the "recommendations" provided to them. Over the thirteen years that were examined by the Subcommittee, the offshore trustees rarely questioned a "recommendation" made by a Wyly trust protector and typically implemented the "recommendation" within days of receiving it.
The Senate Subcommittee saw no evidence that the trustees acted independently to initiate or implement financial transactions or investments on their own. Instead, the offshore trustees appeared to have functioned as administrative cogs to implement the decisions conveyed to them by Wyly representatives about trust assets and activities.
The Subcommittee discovered how, over a ten year period from 1992 to 2002, Sam and Charles Wyly transferred offshore over 17 million stock options and warrants that had been awarded to them as compensation from Michaels, Sterling Software, and Sterling Commerce. The Wyly's transferred these stock options and warrants, collectively worth at least $190 million, to the offshore shell corporations owned by the offshore trusts benefiting their families. For the most part, the Wylys received in exchange annuity agreements in which the offshore corporations promised to make future annuity payments to the Wylys. Their legal counsel provided written legal opinions concluding that, because the stock options and warrants had been exchanged for annuities of equivalent value, the Wylys did not have to pay taxes on the gains realized when the offshore corporations exercised the stock options and warrants. Instead, their legal counsel advised that the Wylys owed taxes only if and when they actually received the promised annuity payments from those corporations' years later.
Their legal counsel also provided assurances to three public corporations that had issued the stock options to the Wylys. They advised the public corporations that the offshore corporations were independent of the Wylys, and the public corporations thus did not have to not report any compensation to the IRS when the offshore corporations exercised the options, as no tax was due on the compensation until the promised annuity payments were made. In 2003, the IRS announced that similar stock option transactions were potentially abusive tax shelters, that the Stock option holders should have paid tax on their stock option compensation, and the corporations issuing the stock options should have reported the compensation in 1099 or W-2 filings. The IRS later announced an initiative allowing persons and corporations who participated in such stock option transactions to settle their potential tax liabilities with reduced penalties.
Michaels Stores applied to participate in this settlement initiative; the Wylys did not.
In the Subcommittee report, it was found that the offshore entities used the stock Options and warrants to generate millions of dollars in untaxed investment gains. Their first step was to exercise the stock options and warrants to obtain shares in the three U.S. corporations.
The offshore entities then sold some shares for cash, pledged others to obtain loans, and engaged in a raft of other securities transactions such as collars, call options, equity swaps, and variable prepaid forwards. The decisions to engage in these transactions were made by the Wylys and their representatives, and conveyed by the trust protectors to the offshore trustees who then implemented them. Relying on advice from their legal counsel, the Wylys did not pay taxes on any of the offshore trusts' trading gains, even though the U.S. tax code requires that income earned by a trust controlled by a U.S. person who funded or is a beneficiary of the trust be attributed to that U.S. person for tax purposes. The Wyly legal position was that the offshore trusts were independent entities whose income was not attributable to any U.S. person.
The Wylys did not include the stock holdings of the offshore entities in their filings with the SEC until 2005, even though it's required by SEC regulations that large stockholders are to disclose all of the shares they beneficially own as well as shares held by groups with whom they acted in concert to buy and sell the securities. Legal and securities advisers for the Wylys took the position that the offshore trusts were independent entities whose securities did not have to be reported in the Wyly filings. Wyly legal advisers and representatives also helped the offshore entities to go around SEC disclosure requirements for major shareholders, represented to U.S. financial Institutions that the entities were exempt from SEC trading restrictions on affiliates, and helped offshore entities conduct securities transactions during periods when the Wylys possibly had material insider information. The brokers who carried out these securities transactions, with one exception, treated the offshore entities as nonaffiliated, even though they knew the Wylys and their representatives' exercised significant direction over the investment activities of the offshore entities.
The three public corporations failed to disclose the offshore holdings in their SEC filings even though they knew the offshore entities had large stock holdings and were associated with the Wylys. As a result, for a number of years until 2005, U.S. securities regulators and the investing public were unaware of the extent of the Wyly-related offshore stock holdings and trading activity.
The Subcommittee found that the Wylys made use of untaxed offshore dollars to advance their business and personal interests in the U.S.
It was discovered that millions of untaxed dollars were returned to Wyly interests in the U.S. using pass-through loans channeled through a Cayman shell corporation called Security Capital. More than $600 million in untaxed dollars were invested in Wyly-related business ventures, including two hedge funds, a private equity fund, an offshore insurance company, and a U.S. energy business, all of whom used these funds on U.S. investments. About $85 million in untaxed dollars were used to acquire U.S. real estate and build houses for use by Wyly family members, and untaxed dollars were used to finance real estate loans that supplied millions of offshore dollars to Wyly family members for their personal use in the U.S. The Wylys used $30 million in untaxed dollars to purchase furnishings, artwork, and jewelry for the personal use of Wyly family members. Each of these transactions was the result of decisions initiated and planned by the Wylys and their advisors, and not by the offshore trustees or the executives of the offshore corporations who executed them. Law firms provided the Wylys the guidance on how to structure these transactions purportedly to comply with U.S. tax and securities laws and drafted the paperwork needed for them to function; brokers facilitated the multi-million-dollar international wire transfers that financed this activity.
On issues related to compliance with U.S. anti-money laundering (AML) laws, the Subcommittee found that many of the offshore entities opened accounts with U.S. securities firms or the securities divisions of U.S. banks. For decades, U.S. banks have been compelled to "know their customers," including the natural persons behind offshore corporations and trusts, in order to ensure that bank services are not misused for further misconduct. In 2001, the USA PATRIOT Act extended that requirement to U.S. securities firms who, until then, had operated AML programs on a voluntary basis.
In provisions that became effective in 2002, the USA PATRIOT Act required U.S. banks and securities firms opening a private account with at least $1 million for a non-U.S. person to "ascertain the identity of the nominal and beneficial owners" of the account.
In 2003, two U.S. financial institutions repeatedly requested that the Wyly-related offshore entities to provide the names of their beneficial owners. While the offshore entities let it be known that they were associated with the Wyly family, they declined to disclose the names of specific individuals who were associated with particular offshore entities. The offshore entities also submitted W-8BEN forms to the financial institutions, representing that they were independent foreign entities not subject to certain IRS requirements for reporting investment income paid to U.S. persons, even though U.S. taxpayers exercised significant direction over the offshore entities' assets and investment activities. The financial institutions accepted the W-8BEN forms and allowed the accounts to continue operating without sufficient beneficial owner information, and continued to facilitate multi-million-dollar securities transactions and wire transfers across international lines. In late of 2004, however, after receiving subpoenas from U.S. law enforcement agencies who were seeking information on the accounts held in the name of the offshore entities, the financial institutions closed the accounts.
Sam and Charles Wyly harvest a number of benefits from their offshore activities, including years-long deferral of taxes on millions of dollars in stock option compensation, nonpayment of taxes on millions of dollars in capital gains held by offshore trusts directed by them, a ready source of capital for their business ventures, and a ready source of funds to finance their personal interests
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