© 2015 The Texas Lawbook.
By Mark Curriden
(Jan. 27) – U.S. Bankruptcy Chief Judge Barbara Houser told lawyers for Sam and Dee Wyly Wednesday that she has “a lot of heartburn” about some of the tax-free offshore trusts the Wylys established during the 1990s, which the judge said were created based on “flat out lies.”
“Where did the money go?” the judge asked the Wylys’ lawyers about the hundreds of millions of dollars the Wylys deposited in offshore trusts on the Isle of Man during the 1990s. “What happened to the dough? Where did it go?”
The judge’s comments and tough questions to lawyers for the Wylys and equally probing inquiries of the Internal Revenue Service came during closing arguments in the unprecedented three-week, billion-dollar bankruptcy trial for the Wylys, who have been accused by federal regulators of using offshore trusts to hide revenues and avoid taxes.
The Wylys filed for protection under Chapter 11 of the U.S. Bankruptcy Code in 2014 after a New York judge hit Sam Wyly and his now-deceased brother, Charles, with a $299 million judgment for federal securities violations involving offshore trusts the family created in the 1990s in the Isle of Man.
Last April, the IRS accused the Wylys of tax evasion and fraud related to the offshore trusts. The IRS seeks $1.4 billion in back taxes, fees and penalties from Sam Wyly and $800 million from Charles Wyly’s widow, Dee Wyly. Charles Wyly died in a car crash in Colorado in 2011.
The IRS claims that the Wylys, who made their billions growing and then selling Michaels Stores and Bonanza steakhouses, set up a series of offshore trusts in the Isle of Man in order to hide income from being taxed, while still using the money in the trusts to fund their lavish lifestyle. The government claims that the trusts were sham operations that were used to purchase multimillion-dollar houses, $700,000 pieces of jewelry and artwork any time the Wyly family demanded it.
The legal and factual issues in the case are complex. The IRS must prove beyond a “preponderance” of the evidence that the Wylys owe back taxes on the money from the trusts, but the government also must show “clear and convincing” evidence that the Wylys committed tax fraud.
“We have produced a mountain of evidence,” IRS prosecutor Jonathan Blacker told Judge Houser Wednesday during closing arguments. “Fraud occurred each and every year that this offshore trust system existed.”
“The Wylys used these trusts as their tax-free personal piggyback,” Blacker said.
Blacker told Judge Houser that the Wylys’ violation of federal securities laws for the purpose of avoiding taxes is evidence of tax fraud.
“Fraud doesn’t get any clearer than that,” Blacker said. “Short of Sam on the witness stand saying he did, we can’t get any closer than that.”
“That’s not true,” Judge Houser interrupted. “That doesn’t prove tax fraud.”
Judge Houser said the fact that the Wylys owed back taxes as a result of their securities violations doesn’t automatically mean the Wylys are guilty of tax fraud, which she noted has a different legal standard.
The question of tax fraud is key because $930 million of the $1.4 billion the IRS is seeking against Sam Wyly are penalties for alleged fraud.
A lawyer for the Wylys told Judge Houser that the Wylys violated no tax evasion or tax fraud laws when they moved their money into tax-free offshore trusts because they relied on the advice of their lawyers that it was legal.
“Opinions were sought. Opinions were given. Opinions were relied upon by the Wylys,” Don Lan said during closing arguments.
“Really? I’m not buying it,” Judge Houser responded. “If that’s true, any taxpayer can hide behind the shield” of having their business “agents go out and hire some schmuck” to develop “a fraudulent trust” and never face any consequences.
“If that’s the law, it’s not sitting very well,” the judge said.
Lan told Judge Houser that the court has dozens of memos, emails and written opinions by lawyers and tax professionals that the Wylys relied on when they were creating the trusts on the Isle of Man.
“The issue is, what did Sam know?” said Lan of the Dallas law firm Lan Smith Sosolik. “Knowledge is critical, because you can’t violate something you don’t know.”
“Oh, come on,” Judge Houser, her face in her hands and leaning forward from the elevated bench, again interrupted. “Sam had to know. Sam doesn’t seem like a shy guy. Why didn’t he ask why they were doing this?”
Lan told the judge that the Wylys were told that the trusts were “aggressive, but not illegal.”
“It may have been risky, but risky is not illegal or even wrong,” Lan said.
“Then why all the secrecy?” Judge Houser asked. “Why put all information offshore?”
“It’s not illegal,” Lan responded.
“Concealment is a badge,” Judge Houser shot back. “It’s bricks in a case.”
Lan pointed out that when the Wylys learned of the potential tax issues in 2003, they immediately self-reported it to the IRS.
“Those are not the actions of someone who is guilty,” Lan said.
Blacker told the court that the Wylys only “self-reported” in 2003 after they learned that they were about to be hit with subpoenas from the IRS.
“Of course, annuities were paid” at that point,” Blacker said. “The jig was up. The IRS was on them.”
Judge Houser also told the IRS that she has doubts about its argument that distributions of money from the trusts are technically “reportable events,” which would require the Wylys to file notice of the distribution to the IRS, which they did not do. She said the evidence shows the money from the trusts was distributed to other entities, such as limited liability corporations and not to the Wylys as individuals.
“The debtors say they don’t understand your theory on this, and, quite frankly, I don’t understand it either,” Judge Houser said.
Lawyers for the Wylys say that if the IRS cannot prove that the distributions were a “reportable event,” then about $500 million in the IRS proposed penalties evaporate.
Judge Houser said that her tough questions of the lawyers for either party does not in any way indicate how she will eventually rule in the case.
“Don’t put too much hope or despair in any of my questions today,” the judge told the courtroom. “I have not decided what the answer is.”
The trial was expected to end Wednesday, but closing arguments will continue Thursday because both sides went significantly longer than expected.
“I’m not going to short drift you on these issues,” the judge said. “I need to be able to understand these issues before I can decide them. As much as it pains me to admit, I think we need to come back tomorrow.”
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