Billionaire Brothers Long Suspected of Tax Evasion

Sam and Charles Wyly have long cultivated an image as active philanthropists, funneling millions of dollars to arts groups, colleges, literacy programs and animal shelters.

Source: charlesandsamwyly.com Sam and Charles Wyly

But government investigators have suspected for years that the billionaires from Dallas had a less community-minded goal: avoiding taxes. Along the path they chose for structuring their business interests, they have engaged in a $550 million securities fraud, the Securities and Exchange Commission said in a civil complaint filed on Thursday.

A substantial portion of the Wyly brothers’ money has been stowed for years in a complex web of offshore companies and trusts whose purpose is to minimize the tax bills, according to a 2006 Congressional investigation into tax havens.

The trusts, which have sheltered assets worth at least $750 million at various times, have owned mountain ranches in Colorado, a million-dollar painting of Benjamin Franklin, a $750,000 emerald necklace and antique furniture — all of which the Wylys were able to use on loan from the trusts.

On paper, however, the Wylys were, for many years, relative paupers. When they needed cash for investments or purchases, it frequently came in the form of tax-exempt loans from the trusts.

Through their representatives, the Wylys say that they depended on the opinions of lawyers and accountants to ensure that their offshore transactions were legal. And they dispute the idea that the brothers were seeking to avoid paying taxes. Rather, taxes were deferred, to be paid later when income was drawn from the accounts, they said.

“They were never given any reason to believe the financial transactions in question were anything other than legal and fully appropriate,” their lawyer, William A. Brewer III, said in a statement.

One of the legal opinions they relied on came from a lawyer who was later sentenced to prison for an unrelated tax and money-laundering conviction. But multiyear investigations into the Wylys’ tax strategies by the Justice Department, the Internal Revenue Service and a Congressional committee had not produced any major charges until the Securities and Exchange Commission filed its suit.

The commission accused the brothers of creating “an elaborate sham system” of trusts and companies, on the Isle of Man in the Irish Sea and in the Cayman Islands in the Caribbean, that produced $550 million in undisclosed gains on stock sales. Through the investment entities, the S.E.C. said, Samuel E. Wyly and Charles J. Wyly Jr. violated securities laws that require corporate directors and executives to report stock trades.

Robert M. Morgenthau, the former Manhattan district attorney, also conducted an investigation into the Wylys’ tax shelters in 2004, and although he found that his office did not have jurisdiction over the Texas residents, he said he was certain something was wrong.

“When you hide money overseas under fictitious names, it’s kind of a presumption that it’s not legal,” Mr. Morgenthau said on Friday.. “It looked to us like there were tax law violations.”

Mr. Morgenthau said he referred the results of his investigation to the I.R.S. It was reported by various news outlets in 2006 that the Justice Department and the I.R.S. were conducting investigations. Those entities declined to comment on the status of those investigations. A person close to the Wyly brothers, who spoke on the condition of anonymity, said the Wylys were unaware of the inquiries.

Tax experts note that it is not illegal to try to minimize the taxes that one pays to the government. “There is a whole range of tax planning out there, and most of it is done in an attempt to reduce taxes,” said Michael S. Knoll, a professor at the University of Pennsylvania Law School. But there is a difference between tax avoidance, which is legal, and tax evasion, which is not.

The offshore trusts and management companies were set up by the Wylys beginning in 1992, and many of them were named for towns and schools in Louisiana that were associated with the brothers’ youth. Among them were East Carroll, the parish where they grew up, and Delhi, where they attended high school.

AP Sam Wyly poses in front of his Explore book store, Aspen, Colorado, in 2008.

Over a period of seven years, the S.E.C. contends, the two men transferred to the offshore companies options and warrants on millions of shares of Michaels Stores, Sterling Software and Sterling Commerce, companies they founded or controlled. The transfers were made in exchange for annuities that would pay out the value of the securities over time.

Such an arrangement would not be illegal if the trusts were operated independently of the Wylys. But the S.E.C. contends that the brothers directed all of the investment activity of the trusts and transferred proceeds from some transactions — which they characterized as loans — into their own bank accounts in the United States.

The trusts and offshore corporations individually owned small percentages of the shares of each company. But the S.E.C. also asserts that those trusts were in fact controlled by the Wylys, and therefore the aggregate holdings, which were 16 to 36 percent of the companies’ total shares, should have been disclosed.

Other legal scholars say that the S.E.C. could have trouble proving at least parts of its case. Jonathan R. Macey, a professor at Yale Law School who is not affiliated with the case but who was recommended as an insider-trading expert by the Wyly legal team, said he believed the insider trading portion of the S.E.C. charges rested on a novel and suspect legal theory.

“The question is whether it is possible to engage in insider trading when the information you are trading on is something that you thought up yourself,” Professor Macey said. “They had an idea to talk to other companies about a merger. It’s a pretty edgy notion.”

If an executive knows that his company is in undisclosed merger negotiations, trading on that information would clearly be illegal, Professor Macey said. The Wyly case, however, does not allege that the company, Sterling Software, was in merger negotiations. It claims that the Wylys, who served as chairman and vice chairman of the company, “had agreed and resolved that the sale of Sterling Software to an external buyer should be pursued.”

The idea came in June 1999, the S.E.C. claims, but formal discussion about a possible sale by company executives did not occur until November 1999. Between those periods, Mr. Macey said, “the S.E.C. is acting as thought police.”

The Wylys have been considerable donors to Republican campaigns and conservative causes over the years. The Center for Responsive Politics found that the brothers and their families donated nearly $2.5 million to roughly 200 federal-level candidates and committees in the last 20 years.

But after it was reported in 2006 that the Wylys were the subject of federal tax investigations, some Republicans distanced themselves from the pair. That year, Senator John McCain, Republican of Arizona, who was planning a presidential bid, and Senator Bill Frist, Republican of Tennessee, then the Senate majority leader, returned $20,000 and $5,000 in donations, respectively, from the Wyly brothers and their relatives.

David Kocieniewski contributed reporting.