How Tax Shelters Brought Trouble to Billionaire Clan

By Glenn R. Simpson

Wall Street Journal 

In 2001, Dallas billionaire Sam Wyly picked from a Christie's catalog a pocket watch once owned by Franklin D. Roosevelt. But Mr. Wyly, who keeps the watch at his home, doesn't own it. Instead, it is owned by a tax-exempt company in the Isle of Man called Audubon Limited -- which Mr. Wyly says he neither owns nor controls. Audubon paid $41,125 for the watch at Mr. Wyly's suggestion, a lawyer for the businessman says, and then lent it to him.

Audubon is part of a network of companies and trusts established on the Isle of Man to park large parts of the Wyly family wealth, a move that shields the money from U.S. taxes and lawsuits. To critics, the ability of the Wylys to enjoy benefits from assets that they don't own illustrates what's wrong with the huge offshore tax-avoidance industry.

Representatives of the Wyly family say the Wylys believed their financial arrangements were entirely legal. A family lawyer, William Brewer, says all the Wylys' offshore structures either are detailed as accepted practices in the American Bar Association's manual on "asset-protection strategies" or were explicitly deemed legal by Congress.

Isle of Man entities connected with Sam Wyly and his brother, Charles, also own expensive jewelry worn by family members and property in an exclusive enclave near Aspen, Colo., called Little Woody Creek. The entities have made loans to Wyly family members, according to documents and Mr. Brewer, and in some cases they pay the brothers stipends known as annuities. Another Isle of Man company paid £154,000 (about $287,000) for a 1910 painting called "Noonday Rest" by British realist John William Godward, which wound up at the home of Kelley Wyly, Sam's daughter.

The Isle of Man is a misty, quasi-independent republic of 75,000 people in the sea between England and Ireland. Much of the Wylys' network was set up from a medieval village at its southern tip by a British businessman known locally for greeting clients with a macaw perched on his shoulder. Ronald Buchanan long worked at an 18th-century mansion known as Lorne House, which was also the name of his business.

One of Mr. Buchanan's main associates working on Wyly trusts was an ex-stockbroker who is now wanted on fraud charges in South Africa. A review of court records, legal opinions and Wyly family memorandums, as well as interviews with lawyers and regulators, shows that the two men helped the Wyly brothers set up more than two dozen offshore companies and trusts over the past 15 years.

The Wyly trusts will be examined tomorrow at a hearing by a U.S. Senate panel called the Permanent Subcommittee on Investigations. The panel's senior Democrat, Sen. Carl Levin of Michigan, has been probing offshore tax evasion and money laundering for several years. The panel is also looking into how the elite New York law firm Cravath, Swaine & Moore LLP provided legal advice on offshore tax shelters to wealthy individuals, people familiar with the probe say.

U.S. prosecutors and regulators already are targeting people who promote offshore tax-avoidance plans. One former lawyer for the Wyly family is now in prison on tax and fraud charges involving work for other clients, while another is under investigation by the Internal Revenue Service. The Wyly family's affairs are now the subject of a federal grand-jury investigation in Dallas.

The Wylys' Isle of Man holdings were largely funded with profits from stock options issued during the 1990s. Most of the options came from the Michaels Stores Inc. craft-store chain, which the brothers acquired control of in 1983. Two investor lawsuits allege some of the Michaels options were improperly granted or dated by the Michaels board. Last month a federal grand jury subpoenaed documents from Michaels, which is one of dozens of companies ensnared in recent investigations into stock-option grants.

The Wyly brothers -- Charles, 72 years old, and Sam, 71 -- have enjoyed a storied life in business as pioneers in computer software, hedge funds and retail. They have been top donors to the campaigns of President George W. Bush. Born at the height of the Great Depression in Lake Providence, La., they grew up in a hardscrabble farm town called Delhi and excelled at Louisiana Tech University, where Charles was a football star and Sam was student-body president.

After working for International Business Machines Corp. in the early 1960s, Sam founded University Computer Co., an early business-computing company, in 1963 and was joined there a year later by his brother. Over the next three decades the pair started or acquired many successful businesses including Bonanza Steakhouse. In 1990, they started Maverick Capital Ltd., an early hedge fund. Richard Hanlon, a former Wyly employee who is on the Michaels board, says Sam Wyly "has always had that combination of the analytical skills you would associate with an astute investor with the innovative thinking of an entrepreneur."

In the early 1990s, Sam went through a high-profile divorce from his first wife, Victoria, and paid a large settlement. That instilled a desire to protect his privacy and assets in the future, says his lawyer, Mr. Brewer. He sent a longtime family employee to a seminar put on by a lawyer named David Tedder, who ran an organization called the Institute for Asset & Lawsuit Protection.

Mr. Tedder also was chief counsel for personal-finance guru Charles Givens, who became famous in the 1980s for airing get-rich-quick infomercials. In 1990, The Wall Street Journal disclosed in a page-one article that Mr. Givens was the subject of fraud investigations by the IRS and the Securities and Exchange Commission. Mr. Tedder was soon defending Mr. Givens in court from disgruntled investors. He also continued giving financial seminars.

In June 1991, the family employee wrote a 26-page memo detailing strategies proposed by Mr. Tedder, whose messages she summarized as "never let a creditor get your asset" and "wherever possible reduce income tax." By early 1992, the Wylys were working directly with Mr. Tedder on a plan to shift offshore tens of millions of dollars in warrants and options from Michaels and another firm, Sterling Software Inc. (The Wylys sold Sterling to Computer Associates, now called CA Inc., in 2000 and became a major CA shareholder.)

Mr. Tedder supplied a 16-page opinion declaring it "more likely than not" that the Wylys could transfer the assets to offshore companies in exchange for regular annuity payments without paying capital-gains tax on the appreciated securities. The letter did warn that "this approach is rather novel." A lawyer for Mr. Tedder, who is in federal prison on unrelated tax and money-laundering charges, said he wasn't available for comment. Some aspects of the transactions were also reviewed by the law firm of Wyly family lawyer Michael French.

J. Richard Duke, a tax lawyer in Birmingham, Ala., who doesn't do business with the Wyly family, says the structure promoted by Mr. Tedder appeals to investors who own a property that has greatly appreciated. "The purpose is to stretch the gain out over your life, and if you die prematurely, the gain is not included in your estate," says Mr. Duke. He adds that he doesn't recommend the structure because it is subject to attack by the IRS.

The IRS requires that for a private annuity to be legal, an investor has to truly surrender control over the asset to someone in a foreign country. But any attempt to add legal protections to ensure that the foreign holder doesn't simply pocket the money could lead the IRS to call the whole thing a sham. "You cannot legally control the structure if it is an offshore structure," says Mr. Duke. "But most Americans are control freaks."

In 1992, the Givens organization began to collapse amid civil-fraud suits. Mr. Tedder moved to Florida to work nearly full time helping Mr. Givens transfer some $50 million in assets to offshore tax havens, including the Isle of Man, so they would be out of the reach of creditors, Mr. Tedder later testified in a federal bankruptcy case. Mr. Givens, who settled many of the fraud cases without admitting wrongdoing, died of cancer in 1998.

The Wyly family began to deal with a Tedder legal associate, Michael Chatzky, and with the Lorne House proprietor, Mr. Buchanan, and his associate, Keith Leslie King, according to correspondence from the period. By 1994, this team was working on a set of trusts to hold still more stock options, primarily from Michaels.

Trusts are commonly used to make charitable bequests, provide for heirs or even provide for one's own future. For tax purposes what matters is whether control of the assets is transferred to someone else. If so -- and if the trust is overseas -- then gains on the assets aren't subject to U.S. tax. (U.S. citizens do have to pay tax on income earned overseas, including income from a foreign trust that they bring back to the U.S.)

Mr. King set up four new foreign trusts for the Wyly brothers and their top family lawyer, Mr. French. The beneficiaries included Wyly family members and Sam Wyly. Mr. King wrote letters to the Wyly brothers saying he was establishing each of the trusts with $25,000 of his own money "to show my gratitude for your loyalty to our mutual ventures and your personal support and friendship." The letters were designed to show that the trusts, as required by the IRS, were established by a foreign individual, Mr. King. However, according to Lorne House records, Mr. King actually put only $1 into each trust. He then put in four promissory notes for the other $99,996, which was never paid.

Isle of Man regulators have since alleged that Mr. King was draining funds from other clients and that he was "involved in a conspiracy to defraud the South African Reserve Bank utilizing forged documents." Mr. King, who is the target of a South African arrest warrant, couldn't be reached for comment.

The Wyly brothers didn't know that Mr. King had failed to pay the full $100,000, says their lawyer, Mr. Brewer. "The Wylys have always attempted to surround themselves with appropriate legal, tax and financial-management professionals," says Mr. Brewer. "Unfortunately, in a few instances, certain individuals may not have been quite as they originally appeared." The brothers vetted the financial products they bought from Mr. Tedder and his associates with better-known practitioners such as a London-based lawyer at the law firm Morgan, Lewis & Bockius and accountants at Ernst & Young. In a 1994 opinion, the Morgan Lewis lawyer endorsed the theory that the trusts established by Mr. King for the Wylys could be used to largely shield gains in assets from U.S. federal taxes.

Many trusts invest their assets conservatively in stocks and bonds. But the Isle of Man trusts took their Wyly money and used it to establish a company in the Cayman Islands that would market offshore annuities to other investors. The result was Scottish Annuity & Life, which was set up and run by Mr. French, the Wyly lawyer, and included both Wyly brothers on its board from 1998 to 2000. Scottish Annuity, since renamed Scottish Re Group Ltd., was eventually taken public on the New York Stock Exchange. It has expanded into the business of reinsuring life-insurance policies issued by other companies and has $12 billion in assets.

This year, Scottish Re disclosed it had received an SEC subpoena regarding transactions early in the company's history by the Wylys and Mr. French, now the company's chairman.

In December 1995, Mr. King was formally banned by Isle of Man regulators from acting as a corporate director due to "concerns regarding honesty and integrity," regulatory documents state, forcing him to resign as a director of Lorne House. Over the next several years, Mr. King's legal troubles were chronicled in the offshore trade press, but the Wyly brothers say their advisers didn't inform them.

In 1996, more trust transactions involving options from Michaels were engineered for the Wyly brothers by Mr. Chatzky, who had parted ways with Mr. Tedder. Mr. Chatzky gave the Wylys a 20-page legal opinion decreeing it "more likely than not" that the deals would be largely shielded from income taxes. He did warn that the IRS "might view the transactions that are the subject of this memorandum in a manner differently than you or I would view them." The Justice Department and the IRS now allege in court filings that at the time, Mr. Chatzky was selling questionable offshore tax shelters to dozens of other wealthy Americans. Mr. Chatzky didn't respond to requests for comment.

The Wyly family continued shifting assets offshore. The trusts established by Mr. King bought real estate, artwork and jewelry used by the Wyly family. Documents show that longtime Wyly family employees in Dallas and the Cayman Islands formed a "protectorates committee" advising the trusts what to buy.

For instance, in 1996 Sam Wyly successfully bid at Sotheby's for the painting by John William Godward. Shortly thereafter, an accountant at another Wyly-founded company in the Cayman Islands sent a letter to Mr. Buchanan at Lorne House stating that the protectorates committee recommended buying the painting.

Mr. Buchanan responded a few days later by questioning whether the painting was a wise investment. The trustee was duty-bound to ensure that the trust's assets were invested wisely. Mr. Buchanan said the painting cost more than double the preauction estimate and was by an artist with a less than top-level reputation.

He quickly received a stern letter from Mr. French. "We need to resolve this issue at once," he wrote, insisting Mr. Buchanan had no legal grounds to question the transaction. Then Sam Wyly himself sent Mr. Buchanan a letter encouraging him to buy the painting. Mr. Buchanan then apologized to Mr. French for appearing "excessively obdurate" and bought the painting.

Trust specialists say it is not illegal for an offshore trust to buy a painting or other valuable object and allow someone in the U.S. to use it, and the trustee can even consider suggestions from the U.S. recipient about what to buy. But the trustee ultimately must make independent decisions.

Bob Davis, who represents Mr. French in the grand-jury and Senate inquiries, says his client isn't a tax lawyer and had a minimal role in setting up and managing the trusts. Mr. French ended his ties to the Wyly brothers in 2000, according to Mr. Davis, and the following year Mr. French's Isle of Man trust was unwound.

Problems surfaced only in 2004, when Bank of America Corp. informed the Wylys it had received a subpoena for information about their bank accounts from Manhattan District Attorney Robert Morgenthau.

In February of this year, Mr. Buchanan died of heart problems. He was described as a respected philanthropist and civic booster in his obituary by the Isle of Man newspaper. "Locally, Ronnie may be better remembered by the people of Castletown for his trips into town with his macaw, Sasha, perched on his shoulder," the notice said. A lawyer for Lorne House declined to comment on the Wyly affair.

Legal experts such as Mr. Duke say the extensive involvement of the Wyly family and their business associates with trusts legally controlled by people offshore may prove to be a legal Achilles' heel. "The legal owner cannot be told what to do," by the Wylys or their agents, says Mr. Duke. Otherwise, courts will likely rule that "he is not being treated as a legal owner. He is a patsy."

Mr. Brewer, the lawyer for the Wylys, says they acted in good faith. "For a period of more than a decade, Sam and Charles have spent more than $10 million to obtain professional advice and oversight concerning asset preservation and estate-planning arrangements," he says. "They expected and understood that all of their actions were in full compliance with the law."

ISS Tody: Will The Tax Havens Of This World Survive The Global Recession?

As the maxim goes, every cloud has a silver lining. There is growing hope that this might turn out to be the case with the fallout from the current global financial crisis. One of the defining characteristics of the crisis is the erosion of confidence in the self-regulating powers of markets. In the wake of the summit of the G20 countries in London last week, some critics believe that the deregulation process has been thrust into reverse gear. There have already been numerous company closures, massive job losses, and market collapse, prompting government bailout initiatives in several countries. These developments appear to herald a new era of greater transparency and international co-operation in combating financial crimes. Experts predict that increasing powers will be given to law enforcement agencies to work across borders to track down unlawful capital flight, especially tax evasion.

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The events of the last few weeks suggest that the predictions about greater regulation are not far fetched. On Thursday 12th March 2009, Liechtenstein and Andorra announced that they were loosening their strict bank secrecy laws. The following day, Austria, Luxembourg and Switzerland followed suit. Why are these long-standing offshore financial centres abandoning their tradition of banking confidentiality? Does this mark the demise of tax havens? If so, what will be the implications for developing countries?

 

The distinct feature of financial offshore centres over the years has been that they offered investment environments for foreign companies to either pay very little tax or no tax at all. In addition, they refused to share information on the identity of such companies or on their financial dealings with other countries. Significantly, they would not co-operate with tax authorities from the countries from which companies doing business offshore originated.

 

This protection was over the years extended to individual offshore investors. As a result, tax havens were therefore ideal for criminal elements, seeking to evade tax and to launder ill-gotten wealth. Following up and investigating corruption and tax fraud presents insurmountable challenges for law enforcement agencies if a tax haven is involved. At the heart of the problem lies the fact that tax havens insist that the inquiring agency should present full information on the identity of the account holder as well as the account details. Often this information is the subject of the inquiry, and therefore not readily available. In February 2009, the Union Bank of Switzerland (UBS), which is the world’s largest wealth management firm, admitted that it had helped some of its American customers to evade US taxes. It agreed to pay a fine of $780million and disclose the identity and account information of 250 American clients. In 2008, some banks in Liechtenstein made similar admissions in respect of high net worth German clients.

 

By facilitating tax evasion and capital flight, tax havens impacted negatively on developing countries - which lost both tax revenues and investment capital. Tax evasion erodes the domestic tax base and contributes to balance of payments deficits persistently experienced by developing countries.

 

It must be emphasized that not every individual or company that banked in these tax havens was involved in tax evasion or money laundering. Offshore investment also involves lawfully earned funds, and could be motivated by the uncertainties of economic management in some countries.

 

The global financial crisis has put pressure on tax revenues of developed countries. It also revealed that many of the most complex debt instruments were based in offshore financial centers. Some leaders in the developed world, such as British Prime Minister Gordon Brown, insist that the lifting of tax secrecy in tax havens is central to turning the economic meltdown around. It is argued that financial regulators in tax havens should be obliged to spontaneously disclose information on the identity of offshore investors. They should also disclose full account details and transactions.

 

In response, the tax havens concede their vulnerability to abuse by tax fraudsters. They are however only prepared to enter into bilateral agreements with specific tax authorities. They are firmly opposed to facilitate ‘fishing expeditions’ by tax authorities. In this regard, they are supported by Article 26 of the Model Tax Convention of the Organisation for Economic Co-operation and Development (OECD), which provides for the sharing of tax information on a case-by-case basis.

 

Article 26 falls short of the demand by Gordon Brown and others for automatic sharing foreigners’ account information. Assuming that he persuades other G20 countries to support him, Brown still has long way to go before the dear of spontaneous disclosure by tax havens becomes reality. For that to happen, much legislation will need to be passed. Secondly, the tax havens will need to renegotiate various double taxation treaties and enter into Tax Information Exchange Agreements with various States. Some of these treaties will be subject to approval in referenda.

 

What do these developments mean for developing countries? It is increasingly being recognized that steps to assist developing countries to move beyond dependence on aid and debt will require measures to tackle capital flight, tax evasion and the abuse of international trade to launder money. The lifting of the veil of banking secrecy by offshore financial centers presents an opportunity for developing countries to track down companies and individuals involved in tax evasion and laundering of proceeds of tax evasion and corruption in tax havens.

 

There are numerous hurdles still to be overcome. In addition to those raised above are the significant capacity deficits in developing countries. The investigation of tax evasion in developing countries is usually impeded by the lack of specialized training in financial investigation amongst law enforcement agencies.

 

In the final analysis, the fate of tax havens as a catalyst for tax evasion and corruption will largely depend on the determination of developed countries to tame offshore financial centres. The quality and depth of the legislation to achieve this will be critical. The devil, as they say, will lie in the detail.

 

Charles Kamba: Consultant Researcher, Organised Crime and Money Laundering Programme, ISS Cape Town

Switzerland to relax banking secrecy law

Source:By Abigail Townsend Telegraph

The Swiss government has bowed to international pressure and agreed to relax the stringent secrecy rules that govern its banks. In a statement ahead of Saturday’s meeting of G20 finance ministers, where offshore banking will be discussed, the government said it would adopt Organisation for Economic Co-operation and Development standards and co-operate with countries investigating tax evasion.

“Banking secrecy does not protect any form of tax offence,” it added. “With the globalisation of financial markets and in particular the current financial crisis, international co-operation on tax matters has become increasingly important.”Gordon Brown welcome the move, adding that it was “important for [Switzerland] to move swiftly to implementation”.

The landmark decision comes amid growing calls for a crackdown on tax havens. There had been threats to include Switzerland on the OECD’s blacklist of uncooperative tax havens, something the world’s biggest offshore financial centre was keen to avoid.

It has also come under pressure from the US, where lawyers want UBS to hand over client details as part of an investigation into tax fraud. But while Switzerland acknowledged concerns about tax havens, it also stoutly defended banking secrecy.

Any co-operation would be on a case-by-case basis only, it said, adding: “[The Federal Council] fully endorses banking secrecy and resolutely rejects any form of automatic exchange of information. The privacy of customers will continue to be protected from unauthorised access to information concerning private assets.”

It will also continue to fight the US over the UBS case. Jean Schaffner, tax partner at Allen & Overy, said it was “a good compromise”, adding: “It is not acceptable for bigger countries to use their economic power to pressure governments into revealing confidential banking information. We don’t anticipate that these announcements will significantly impact the private banking industry.”

Austria and Luxembourg also pledged increased co-operation last week .