EFTA00316104.pdf

JUDGE SUIEIMNDUli Alan M. Lieberman Cheryl J. Scarboro J. Lee Buck, II ) Martin L. Zerwitz SECURITIES AND EXCHANGE COMMISSION 100 F Street N.E. Washington, DC 20549-4030 Tel: (202) 551-4474 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK SECURITIES AND EXCHANGE COMMISSION, Plaintiff, No. 10 Civ. - against - COMPLAINT SAMUEL E. WYLY, CHARLES J. WYLY, JR., JURY TRIAL. DEMANDED MICHAEL C. FRENCH and LOUIS J. SCHAUFELE Defendants. Plaintiff Securities and Exchange Commission ("Commission"), for its Complaint against defendants Samuel E. Wyly ("Sam Wyly"), Charles J. Wyly, Jr. ("Charles Wyly") (jointly, the "Wylys"), Michael C. French ("French") and Louis J. Schaufelc III ("Schaufele"), (collectively, "Defendants"), alleges as follows: SUMMARY OF THE ALLEGATIONS 1. Defendants Sam Wyly and Charles Wyly engaged in a 13-year fraudulent scheme to hold and trade tens of millions of securities of public companies while they were members of the boards of directors of those companies, without disclosing their ownership and their trading of those securities. The Wylys' scheme defrauded the investing public by materially misrepresenting the Wylys' ownership and trading of the EFTA00316104 securities at issue while enabling the Wylys to realize hundreds of millions of dollars of unlawful gain and other material benefits in violation of the federal securities laws governing the ownership and trading of securities by corporate insiders. 2. The public companies involved in the Wylys' scheme to defraud were Michaels Stores, Inc. ("Michaels"), Sterling Software, Inc. ("Sterling Software"), Sterling Commerce, Inc. ("Sterling Commerce"), and Scottish Annuity & Life I loldings Ltd. (now known as Scottish Re Group Limited) ("Scottish Re") (hereinafter collectively referred to as "the Issuers"). The shares of the Issuers were traded on the New York Stock Exchange throughout the period of the Wylys' scheme. 3. The apparatus of the fraud was an elaborate sham system of trusts and subsidiary companies located in the Isle of Man and the Cayman Islands (collectively hereinafter the "Offshore System") created by and at the direction of the Wylys. The Offshore System enabled the Wylys to hide their ownership and control of the Issuers' securities (hereinafter "Issuer Securities") through trust agreements that purported to vest complete discretion and control in the offshore trustees. In actual fact and practice, the Wylys never relinquished their control over the Issuer Securities and continued throughout the relevant time period to vote and trade these securities at their sole discretion. 4. Through their use of the Offshore System, the Wylys were able to sell without disclosing their beneficial ownership over $750 million worth of Issuer Securities, and to commit an insider trading violation resulting in unlawful gain of over $31.7 million. The Wylys' attorney, French, and their stockbroker, Schaufele, substantially assisted the Wylys' fraudulent scheme, each reaping financial rewards for 2 EFTA00316105 doing so. Each also committed primary violations of the antifraud provisions of the securities laws. 5. The Wylys and French knew or were reckless in not knowing their obligations under the federal securities laws as public company directors and greater- than-5% beneficial owners, to report their Issuer Securities holdings and trading on Schedules 13D and Forms 4, public documents filed with the Commission. The Wylys and French also knew or were reckless in not knowing that the investing public routinely used such disclosures to, among other things, gauge the sentiment of public companies' insiders and large shareholders about those companies' financial condition and prospects, thereby relying on them in making investment decisions. Despite their knowledge, the Wylys and French systematically and falsely created the impression that the Wylys' holdings and trading of Issuer Securities were limited to the fraction that they held and traded domestically. By depriving existing shareholders and potential investors of information deemed material by the federal securities laws, the Wylys were able to sell, in large-block trades alone, more than 14 million shares of Issuer Securities over many years, realizing gains in excess of $550 million. The sales generating most of these gains were made pursuant to materially false or misleading Commission filings. 6. The Wylys further exploited their illegal non-disclosure of their offshore Issuer Securities to make a massive and bullish transaction in Sterling Software in October 1999 based upon the material and non-public information that they, the Chairman and Vice-chairman of Sterling Software, bad jointly decided to sell the company. This transaction yielded ill-gotten gains of over $31.7 million when Sterling Software's sale was ultimately announced to the public less than four months later. 3 EFTA00316106  7. Throughout the course of their scheme, the Wylys, French and Schaufele engaged in fraud, deception and material misrepresentation to conceal their actions. These acts included: (i) the making of hundreds of false and materially misleading statements to the Issuers, the Issuers' attorneys, investors, the Commission, and, in the case of Schaufele, to brokerage firm intermediaries, (ii) the establishment and operation of an offshore "Wyly family office" in the Cayman Islands as a conduit and repository for communications and records "which should not be seen in the USA," and (iii) the allocation of the Wylys' offshore holdings of Issuer Securities among different, and often newly created, offshore entities, all under the Wylys' control, solely to avoid making required Commission filings. 8. French utilized his roles as the Wylys' lawyer and fellow director on three of the four Issuers' boards to cover the Wylys' scheme with a false cloak of legality that was essential both to its concealment and its execution. French's assistance to the Wylys' scheme continued during his tenure as Scottish Re's Chairman, when the Wylys, who had left Scottish Re's board, continued covertly to hold more than 5% of its outstanding stock. French also established offshore entities of his own, which he used to control and to trade Issuer Securities without disclosing his ownership or trading as required by law. 9. For his part, Schaufele used his position as the Wylys' stockbroker to conceal from and affirmatively misrepresent to his brokerage firm superiors the Wylys' control over the Issuer Securities held in their Offshore System. Schaufele also directly committed an insider trading violation by trading in Sterling Software common stock through his wife's accounts based upon non-public material information he learned 4 EFTA00316107 through his employment at Lehman Brothers, i.e. the Wylys' intent to make a massive, bullish and undisclosed transaction in Sterling Software offshore. 10. By the conduct described herein: a. the Wylys each violated Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933 ("Securities Act") and Sections 10(b), 13(d), 14(a) and 16(a) of the Securities Exchange Act of 1934 ("Exchange Act"), and Rules 106-5, 13d-1, 13d-2, 14a-3, 14a-9, 16a-2 and 16a-3 thereunder, and aided and abetted (I) violations of Exchange Act Sections 13(a) and 14(a) and Rules 13a-1, 14a-3 and 14a-9 thereunder by Michaels, Sterling Software, Sterling Commerce and Scottish Re; and (2) violations of Exchange Act Section 13(d) and Rules 13d-1 and 13d-2 thereunder by certain of their Isle of Man trustees; b. French violated Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(d), 14(a) and 16(a), and Rules 10b-5, 13d-1, 13c1-2, I4a-3, 14a- 9, 16a-2 and 16a-3 thereunder, and aided and abetted (1) violations of Exchange Act Sections 10(b), 13(d), 14(a) and 16(a) and Rules 10b-5, 13d-1,13d-2, 14a-3 and 14a-9 by Sam Wyly and Charles Wyly; (2) violations of Exchange Act Sections 13(a) and 14(a) and Rules 13a-1, I 4a-3 and 14a-9 thereunder by Michaels, Sterling Software, Sterling Commerce, and Scottish Re; and (3) violations of Exchange Act Section 13(d) and Rules 13d-1 and 13d-2 thereunder by certain Isle of Man trustees; and 5 EFTA00316108  c. Schaufele violated Exchange Act Section 10(b) and Rule 10b-5 thereunder, and aided and abetted violations of Exchange Act Section 10(b) and Rule 10b-5 thereunder by the Wylys. Each defendant will continue to violate the foregoing statutes and rules unless restrained or enjoined by this Court. 11. The Commission seeks injunctive relief, disgorgement of ill-gotten gains, prejudgment interest, civil penalties and other appropriate and necessary equitable relief from all defendants. JURISDICTION AND VENUE 12. This Court has jurisdiction over this action pursuant to Securities Act Sections 20(dX1) and 22(a) [15 U.S.C. §§ 77t(d)(1) and 77v(a)] and Exchange Act Sections 21(d), 21(e), 21A and 27 [15 U.S.C. §§ 78u(d), 78u(e), 78u-1 and 78aa]. 13. Each defendant, directly or indirectly, made use of the means and instrumentalities of interstate commerce, of the mails or of the facilities of a national securities exchange, in connection with the acts, practices and courses of business alleged herein, certain of which occurred within the Southern District of New York. 14. Venue in this district is proper under Section 22(a) of the Securities Act [15 U.S.C. § 77v(a)] and Section 27 of the Exchange Act [15 U.S.C. § 78aa] because a substantial portion of the conduct alleged herein occurred within the Southern District of New York. THE DEFENDANTS 15. Sam Wyly, 75, a resident of Dallas, Texas, served as Michaels' Chairman from 1984 to 2001, and as its Vice-Chairman from 2001 until its acquisition by a 6 EFTA00316109 consortium of private equity firms in 2006; as Sterling Software's Chairman from 1981 until its acquisition by Computer Associates in 2000; as Sterling Commerce's Executive Committee Chairman, and as a Member of its Board of Directors, from December 1995 until its acquisition by SBC Communications in 2000; and as Scottish Re's Chairman from October 1998 until March 2000. Since 1979, he has been permanently enjoined from violating, among other provisions, the antifraud provisions of the Securities Act and the Exchange Act charged herein. See SEC v. Samuel E Wyly et al., Civ. Action No. 79- 3275, Lit. Rd. No. 8943 (., Dec. 6, 1979). 16. Charles Wyly, 76, a resident of Dallas, Texas, served as Michaels' Vice- Chairman from 1984 to 2001 and as its Chairman from 2001 through 2006; as Sterling Software's Vice:Chairman from 1984 until 2000; as a Director of Sterling Commerce and a member of its Executive Committee from December 1995 until 2000; and as a director of Scottish Re from October 1998 until November 2000. 17. French, 67, a resident of Dallas, Texas, served as a director of Scottish Re from May 1998 until May 2007, as its CEO from May 1998 to January 2005, and as its Chairman from March 2000 through March 2006. He also served, along with the Wylys, as a director of Michaels and Sterling Software from 1992 until 2000. French was a partner in the law firm of Jackson & Walker LLP from 1976 through 1992, at which time he left the firm to work directly for the Wylys. French also served as a protector of the Isle of Man trusts established by the Wylys from 1992 through January 2001—and continued to assist the Wylys with respect to their Offshore System periodically thereafter. He is presently employed as a consultant at Challenger Capital Group, Ltd., a financial services company registered with FINRA. 7 EFTA00316110  18. Schaufele, 55, a resident of Dallas, Texas, served for over fifteen years as the registered representative for various accounts established by the Wylys and French, including the securities accounts of the Wylys' and French's offshore entities. Prior to joining the Dallas office of Bank of America in 2002, Schaufele had worked at the Dallas offices of Lehman Brothers and First Boston. He is presently employed bye. Morgan Securities, Inc. THE ISSUERS 19. Michaels is a corporation headquartered in Irving, Texas that sells arts and crafts supplies and products in retail stores throughout the United States and Canada. Prior to being acquired by private equity firms for $6 billion in 2006, Michaels' common stock was registered with the Commission pursuant to Exchange Act Section 12(b), and was traded on the New York Stock Exchange. The Wylys purchased Michaels in 1983 and, after taking in public in 1984, built it into the nation's largest arts and crafts retailer. 20. Sterling Software was a corporation headquartered in Dallas, Texas that developed and supplied systems management, business intelligence and application development software products and services. It was acquired by Computer Associates International, Inc. in March 2000 for approximately $4 billion worth of Computer Associates stock. Until its acquisition, Sterling Software's common stock was registered with the Commission pursuant to Exchange Act Section 12(b), and was traded on the New York Stock Exchange. The Wylys founded Sterling Software in 1981 and built it into one of the country's largest business software and services companies. 21. Sterling Commerce was a corporation headquartered in Dallas, Texas that developed, marketed and provided software products and services that enabled businesses 8 EFTA00316111 to engage in E-Business communications. It was acquired by SBC Communications, Inc. in March 2000 for $4 billion. Until its acquisition, Sterling Commerce's stock was registered with the Commission pursuant to Exchange Act Section 12(b), and was traded on the New York Stock Exchange. Sterling Commerce was spun off from Sterling Software in 1996. 22. Scottish Re is a holding company organized under the laws of the Cayman Islands with its principal executive office in Bermuda. It is engaged in the reinsurance of life insurance, annuities and annuity-type products written by life insurance companies and other financial institutions located in the United States and abroad. At all relevant times, Scottish Re's common stock was registered with the Commission pursuant to Exchange Act Section 12(b), and was traded on the New York Stock Exchange. In 2008, it was delisted from the NYSE and deregistered under Exchange Act Sections 12(b) and 12(g), and has since been quoted on the Pink Sheets. Scottish Re was established by French and the Wylys in the mid-1990s and was taken public in 1998. FACTS TIM WYLYS CREATE AND FUND THEIR OFFSHORE SYSTEM WITH TENS OF MILLIONS OF ISSUER SECURITIES 23. Between March 1992 and January 1996, in the Isle of Man, a self- governing British crown dependency located between Scotland and Northern Ireland in the Irish Sea, Sam Wyly established ten (10) trusts and Charles Wyly established seven (7) trusts (collectively the "Offshore Trusts"), naming many of them for places or events of personal significance. Among the Offshore Trusts' names, for example, were Louisiana towns and schools associated with the Wylys' youth, including Lake Providence, where the Wylys were born, Delhi, where the Wylys attended high school, 9 EFTA00316112 and Tallulah, the Wylys' football rival high school. The beneficiaries of each of the Offshore Trusts were Sam or Charles Wyly, their respective family members, or both. 24. Initially, the Wylys selected a single Isle of Man-based trust management company to serve as their Offshore Trusts' trustee. Between 1992 and 2004, however, the Wylys selected numerous additional Isle of Man-based trust management companies to serve as their Offshore Trusts' trustees (the "Offshore Trustees"). Employees of the various respective Offshore Trustees served as directors of more than thirty (30) Isle of Man-based shell companies that were wholly-owned by the various respective Offshore Trusts ("Offshore Companies"). Like the Offshore Trusts, many of the Offshore Companies were given names of personal significance to the Wylys, including East Carroll, the Louisiana Parish where the Wylys grew up, and Tensas, the bayou site of the Wylys' boyhood home. These Offshore Companies, along with the Offshore Trusts, comprised the Wylys' Offshore System. 25. Commencing with the initial establishment of their Offshore System and continuing, at various times, over the next seven years, the Wylys transferred to their Offshore System millions of stock options and warrants in Michaels, Sterling Software and Sterling Commerce that they had first received from those Issuers as director compensation. These transfers, which provided the bulk of the funding for their Offshore System, included the following: a. In April 1992, the Wylys transferred options and warrants for 960,000 Michaels shares and 1,983,588 Sterling Software shares to ten of their Offshore Companies, whose ownership was divided among two of their Offshore Trusts; 10 EFTA00316113  b. In December 1992, the Wylys transferred options for an additional 1 million Sterling Software shares to three of their Offshore Companies, each owned by a different Offshore Trust; c. In December 1995, the Wylys transferred options for 1.35 million Michaels shares and 1.65 million Sterling Software shares to five of their Offshore Trust's; d. In January 1996, the Wylys transferred options for another 1 million Sterling Software shares to two of their Offshore Trusts; e. In March 19%, the Wylys transferred options for 4.6 million Sterling Commerce shares to two of their Offshore Trusts; and f. In September 1999, the Wylys sold options for 2.625 million Sterling Software shares and 712,500 Sterling Commerce shares from their domestic holdings to four of their Offshore Companies owned by four different Offshore Trusts,. 26. The Wylys also arranged for their Offshore System to acquire stock options, warrants and common stock in Michaels and Scottish Re in private placement transactions directly with those Issuers; These private placements included the following: a. On March 29, 1996, Michaels entered into private stock purchase agreements with three Offshore Companies through which the Offshore Companies acquired 2 million restricted shares of Michaels for $25 million; b. On December 23, 1996, Michaels entered into option agreements with two Offshore Companies through which the Offshore Companies 11 EFTA00316114  acquired, for El million, options to purchase 2 million Michaels shares at $10.50 per share; c. In June 1998 and October 1998, before Scottish Re's initial public offering, two Offshore Trusts and two Offshore Companies entered into multiple private transactions with Scottish Re through which they ultimately acquired 1.65 million Class A warrants and 937,220 common shares of Scottish Re. 27. The Wylys' Offshore System obtained additional millions of shares of Sterling Commerce in October 1996, when Sterling Commerce was spun-off from Sterling Software. All Sterling Software shareholders received 1.5926 shares of Sterling Commerce as a dividend for each Sterling Software share owned. As a result of this dividend payment, the Wylys' Offshore System acquired nearly 3 million additional shares of Sterling Commerce. 28. The Offshore System's Issuer Securities were held in U.S. brokerage accounts in the names of the Offshore Companies. The Wylys selected the stockbroker and the firm where these Issuer Securities were held. Over the relevant period, these finns were C.S. First Boston, Lehman Brothers, Bank of America Securities and Bear Steams. The accounts at C.S. First Boston, Lehman Brothers and Bank of America Securities were all serviced by Schaufele, the Wylys' longtime broker, who also served as broker for their domestic holdings. Virtually all of the Wylys' offshore Issuer Securities transactions were executed through Schaufele or persons under his direction and control. 12 EFTA00316115  THE WYLYS WERE THE BENEFICIAL OWNERS OF THE ISSUER SECURITIES HELD BY THEIR OFFSHORE SYSTEM The Wylys Appointed Trusted Loyalists to Serve as "Protectors" 29. Although the language of the trust agreements governing the Wylys' Offshore Trusts purported to confer upon the Offshore Trustees broad and exclusive authority to manage the trust assets, this authority was illusory. Under the trust agreements, trust Protectors were granted the right "to remove, appoint or replace any Trustee with or without cause at any time," as well as the right to add or remove trust beneficiaries. In practice, the Offshore Trusts were controlled by these Protectors, who were Wyly-appointed loyalists whose livelihoods were dependent on the Wylys and whose function was to ensure that the Wylys' instructions for the Offshore Trusts were executed. 30. In March 1992, when the Offshore Trusts were created, the Wylys appointed two individuals to serve as the Protectors: their lawyer, French, and their longtime family office CFO (the "Wyly Family CFO"). In late 1995, the Wylys hired a Cayman Islands-based accountant (the "Cayman Accountant") to assist the Protectors in administering the Wylys' Offshore System. The Cayman Accountant's responsibilities increased over the years, and by 1998, had risen to equal those of a Protector. In January 2001, the Wylys formally replaced French as a Protector with the Cayman Accountant, and in November 2004, the Wyly Family CFO (who had ceased serving as CFO of the Wylys' Family Office in 1999) also stepped down as a Protector, leaving the Cayman Accountant as the Offshore Trusts' sole protector. During their terms as Protectors, French, the Wyly Family CFO and the Cayman Accountant derived most, if not all, of 13 EFTA00316116 their compensation either directly from entities owned or run by the Wylys, or from work performed for such entities. 31. The Wylys employed a protocol for effecting transactions in their Offshore System. One or both of the Wylys conveyed instructions to the Protectors for transactions to be executed in their Offshore System. The Protectors, in turn, conveyed the instructions to the appropriate Offshore Trustee, who then implemented them by signing the necessary documentation, or, in the case of Issuer Securities transactions, by faxing the necessary trading instructions to Schaufcle or his assistants; or, in the case of structured Issuer Securities transactions, by executing and returning the relevant portion of transaction documents that the Wylys had first negotiated through Schaufele. 32. The Protectors' role was to convey the Wylys' instructions to the Offshore Trustees and ensure that the instructions were followed. To accomplish this, the Protectors were in regular communication with the Offshore Trustees. Between 1992 and early 2005, the Protectors issued thousands of instructions to the Offshore Trustees, several hundred of which directed Issuer Securities transactions. 33. The Protectors never initiated, devised or independently decided what Issuer Securities transactions to present to the Offshore Trustees, and never failed to convey the Wylys' Issuer Securities instructions to the Offshore Trustees. Moreover, the Protectors conveyed to the Offshore Trustees instructions for only such Issuer Securities transactions as were directed by Sam Wyly or Charles Wyly. The Offshore Trustees Implemented the Wylys' Instructions 34. Pursuant to the Defendants' scheme to conceal the Wylys' control over the Offshore System, the Protectors termed their instructions to the Offshore Trustees as 14 EFTA00316117 "recommendations," thereby implying that the Offshore Trustees could exercise discretion by declining to implement them. Like the Protectors, however, the Offshore Trustees never initiated, devised or independently decided what transactions, in Issuer Securities or otherwise, were to be executed by the Offshore System. And just as the Protectors never failed to convey the Wylys' instructions to the Offshore Trustees, the Offshore Trustees never failed, in turn, to implement those instructions. 35. Despite the fact that the Protectors made thousands of "recommendations" for transactions to the Offshore Trustees from 1992 through at least early 2005, many relating to transactions worth tens of millions of dollars, the Offshore Trustees never deviated from executing such "recommendations." When a "recommendation" came to the Offshore Trustees from the Protectors, they understood it was coming from the Wylys themselves, and, if it was a transaction permitted by the Trust documents, which it effectively always was, it was implemented. 36. The Wylys' instructions, delivered to the Offshore Trustees by the Protectors, frequently left nothing to the Offshore Trustees' judgment or discretion. In many Issuer Securities sales instructions, for example, the Offshore Trustees simply were told by the Protectors which Offshore Company or Offshore Companies were to sell stock, the total number of shares to sell, the maximum number of shares to be sold per day, the minimum price at which the shares could be sold, which broker to use, and how the proceeds were to be invested or applied. Instructions also occasionally required immediate action by the Offshore Trustees, affording them no time for any meaningful review or assessment prior to implementation. Such immediate action items included 15 EFTA00316118 large-block sales of Issuer stock, investments in hedge funds, and wire transfers of cash to other Wyly-run entities. 37. The Wylys excluded the Offshore Trustees from negotiations of large Issuer Securities transactions entered into by the Offshore Companies. In every case, such transactions were first agreed upon by the Wylys and the terms were then negotiated between the brokerage house (most typically Lehman Brothers acting through Schaufele) and the Wylys (frequently represented by other Wyly family members, the Protectors, or both). As many of these transactions involved multiple Offshore Companies administered by different Offshore Trustees, each Offshore Trustee received only the finalized transaction documents concerning its portion of the overall transaction, whereas the Wylys, by contrast, knew and approved of the entire transaction in advance. 38. With regard to voting of Issuer Securities held offshore, the Offshore Trustees always voted the shares consistent with the Wylys' expectations. On the few occasions where the Wylys' wishes were not obvious from the proxy materials, the Offshore Trustees asked one of the Protectors for guidance on how they were to vote the Issuer Securities proxies. On such occasions, the Protector asked the Wylys how they wanted the Issuer Securities voted and relayed the answer to the Offshore Trustees, who always complied. 39. On several occasions, the Wylys or others deviated from the protocol for communications with the Offshore Trustees, by bypassing the Protectors, the Offshore Trustee, or both. For example: a. In September 1992, Sam Wyly directly contacted one of the Offshore Trustees and placed an order to sell Michaels stock "now that the price 16 EFTA00316119  has hit $29.50." A limit order was placed to sell 100,000 shares at $28.50 or better; however, because Michaels' share price dropped soon thereafter, the offshore system was able to sell just 37,000 shares at or above that limit price. b. In July 1993, a principal of the same Offshore Trustee notified French that "[I]requently, the first we know of a deal is when we read that the broker has settled [the transaction) ... We presume that the unorthodox deals are being placed by the Settlor [Sam Wyly)." Instead of insisting that such behavior cease, however, the principal asked only that Sam Wyly indemnify the Offshore Trustee from any liabilities arising from his conduct and that, in the future, the Wyly Family Office notify the Offshore Trustee of such trades at the time Sam Wyly placed them with the broker. c. In November 1995, Sam Wyly spoke directly to Schaufele and offered to let Schaufele's firm, Lehman Brothers, cancel a transaction Lehman had recently entered into with the Wylys' Offshore System since Sam Wyly "didn't want to hurt Lehman." d. In 2001, the then-CFO of the Wylys' family office contacted Schaufele's assistant at Lehman Brothers and, following Charles Wyly's directions, directly placed an order to sell 100,000 shares of Michaels at $42 or better on behalf of one of Charles' Offshore Companies. Lehman sold 82,500 of the shares prior to receiving any 17 EFTA00316120  instructions from the Offshore Trustee. The Offshore Trustee never complained about the then-Wyly Family CFO's actions. The Wylys Closely Monitored the Assets in their Offshore System 40. The Wylys and the Protectors spent considerable time and effort closely monitoring the assets and activities of their Offshore System. The Protectors held semi- annual meetings with the Offshore Trustees, usually in the Isle of Man, to review the Offshore Trustees' records, among other things. The Wylys also had the Cayman Accountant maintain, in the Cayman Islands, a comprehensive set of books and records concerning the Wylys' holdings and activities in each of the Offshore Trusts and Offshore Companies. 41. The Cayman Accountant, who was hired to establish an entity in the Cayman Islands to, among other responsibilities, keep the books and records concerning the Wylys' Offshore System outside the United States, used those books and records to prepare detailed monthly financial reports for both Sam Wyly and Charles Wyly (the "Monthly Offshore Reports"). These Monthly Offshore Reports consolidated the respective assets and liabilities that Sam Wyly and Charles Wyly each held in the Offshore System, and also broke out the assets and liabilities, within Sam's and Charles' respective portions of the Offshore System, by Offshore Trust and Offshore Trustee. When combined with similar reports the Wylys received regarding their domestic assets and liabilities, the Monthly Offshore Reports provided the Wylys a complete picture of their net worth. The Wylys used these reports to decide, among other things, which portions of the assets they controlled would be tapped to generate funding for transactions into which they desired to enter. 18 EFTA00316121  The Wylys Controlled and Enjoyed the Benefits of their Offshore System's Assets 42. The Wylys' transfer of millions of Issuer Securities to their Offshore System did not prevent or limit the Wylys from enjoying the benefits of those assets in the United States. Once the Issuer Securities held in their Offshore System were, at the Wylys' direction, sold, or used as collateral for various loan transactions, the Wylys freely availed themselves of the resulting proceeds. The Wylys directed the Offshore Trustees to invest a total of approximately S300 million of the proceeds in three funds, two of which were hedge funds that Sam Wyly created (Maverick Fund and Ranger Fund), and the third of which was a private investment fund Charles Wyly created (First Dallas). The Wylys additionally directed the Offshore Trustees to invest nearly $200 million in Green Mountain Energy Company, a clean energy company that Sam Wyly acquired in 1998 and attempted to take public in 1999. 43. The Wylys used the proceeds from their offshore stock sales to purchase tens of millions of dollars worth of art, collectibles and jewelry. All of the items purchased by the Offshore System were personally selected by either Sam Wyly or Charles Wyly (or their wives) and kept at Wyly family members' homes or businesses, or worn on their persons, in the United States. After the items were purchased, the Protectors forwarded the hills or invoices to the designated Offshore Trustee, along with a "recommendation" for payment, which was always followed. 44. The Wylys spent nearly S100 million of the proceeds from their offshore stock sales to purchase real estate in the United States for use by Wyly family members as residences, vacation homes and Wyly-run business ventures. Wyly family members selected the purchased properties, oversaw the properties' construction and renovations, I9 EFTA00316122 and exclusively used the properties once the work was completed. After the properties were chosen, the Protectors directed the Offshore Trustees to have the Offshore System provide the funds necessary to purchase the properties. The properties purchased using offshore funds include two ranches in Aspen, Colorado used by Sam Wyly's and Charles Wyly's families respectively; two condominiums located in downtown Aspen, Colorado, one of which is used by an art gallery that is part-owned by one of Sam Wyly's daughters; and a 100-acre horse farm outside Dallas, Texas formerly run as a business venture by one of Charles Wyly's daughters. 45. The Wylys used offshore cash to cover charitable commitments each had made. In 1996, for example, Sam Wyly pledged to donate $10 million to his business school alma mater over five years in connection with the construction of a new building on campus, which was subsequently built and named for him. Although Sam Wyly made the initial $2 million portion of this donation from domestic sources, he caused the remaining $8 million to be paid from the Offshore System. Similarly, Charles Wyly used cash from his Offshore System to fund a five-year, $2.5 million charitable-donation commitment he had made to a church in the United States. Because distributions from the Offshore Trusts could be made onlY.to Trust beneficiaries, the Wylys first had the Protectors add their selected charities as beneficiaries prior to making these, and other, charitable donations from their Offshore System. 46. The Wylys transferred a total of approximately $120 million of the proceeds from their offshore Issuer Securities sales into their own U.S. bank accounts and U.S. bank accounts of other Wyly-related entities. Although these transfers were characterized as loans, their repayment terms allowed the Wylys to pay only the interest 20 EFTA00316123 annually and to defer paying back any principal on many of the loans for up to 15 years. To obscure the source of these transfers, the Wylys structured the loans so that they would pass through a Cayman Islands entity established solely for the purpose of entering into back-to-back loans with the Wylys' Offshore System and the Wylys and other Wyly- related entities. THE WYLYS FAILED TO DISCLOSE IN THEIR SEC FILINGS THEIR BENEFICIAL OWNERSHIP OF THE ISSUER SECURITIES HELD IN THE OFFSHORE SYSTEM 47. As beneficial owners of greater than 5% of each of the Issuers' outstanding shares, the Wylys were legally required to report their total securities holdings for each Issuer and all material changes thereto on Schedule 13I)s filed with the SEC pursuant to Exchange Act Section 13(d). They were also required, during the period they served as directors for each of the Issuers, to report all their trading of Issuer Securities, regardless of amount, on Forms 3, 4 and 5 filed with the SEC pursuant to Exchange Act Section 16(a). 48. Despite maintaining their beneficial ownership over the Issuer Securities held in their Offshore System, the Wylys purposefully omitted those securities from their Schedule 13D and Section 16 filings. Between April 1992, when the initial transfer of Issuer Securities offshore occurred, and April 2005—when, after learning of the SEC investigation, the Wylys first disclosed their (by then largely historical) offshore Michaels securities holdings, in an amended Schedule 13D filing, as holdings which "may be deemed" beneficially owned by them— the Wylys failed to include their offshore securities in any of the more than thirty (30) Schedules 13D or 13G, or the more than one-hundred (100) Forms 3, 4 and 5, they filed with the SEC. The Wylys also failed to file at least forty (40) Schedule 13Ds and at least seventy (70) Form 4s disclosing the 21 EFTA00316124 hundreds of Issuer Securities transactions in their Offshore System that should have been filed had the Wylys reported their ownership and trading of such securities in accordance with law. 49. The Wylys' I3D filing delinquencies as to Scottish Re went unaddressed until December 26, 2006—when the Wylys filed a 13D amendment acknowledging that they "may he deemed" to have been greater-than-5% holders of Scottish Re, and that this never-before-reported status had continued through late October 2004. The Wylys have never addressed their 13D filing delinquencies with respect to their prior holdings in either Sterling Software or Sterling Commerce. 50. None of the Commission filings made by the Wylys ever informed the investing public that the Wylys maintained (or even shared) investment and voting power over the Issuer Securities held by their Offshore System. Although the Wylys did make sporadic and limited disclosures in their Schedule I3Ds and Form 4s about their transfer of securities to trusts, the information the Wylys provided in those filings was grossly insufficient to enable the SEC or the investing public to determine: (i) that the Wylys, in fact, never relinquished control over the "transferred" Issuer Securities, and thus (ii) the full extent of the Wylys' continuing ownership of the Issuers' securities, or (iii) the massive amounts of trading that the Wylys were in fact continuing to conduct in Issuer Securities offshore—including prodigious amounts of selling of the very Issuer Securities they had ostensibly "transferred" to "independent" trusts. 51. In many of their SEC filings, the Wylys affirmatively concealed their control over the offshore Issuer Securities by, for example, falsely "expressly disclaim(ingj beneficial ownership" of the transferred securities and falsely representing 22 EFTA00316125 that they did not "have or share investment control" over the recipient Offshore Trusts. And, on the few occasions where the Wylys were unable to avoid having an Offshore Trustee file a Schedule 13D, the Wylys had the Offshore 'trustee make the materially false and misleading statement in those SEC filings that the Offshore Trustee, alone, held "sole diapositive power and voting power" over the Issuer Securities in question. 52. The Wylys also caused the Issuers on whose boards they sat to report falsely, in the Issuers' annual SEC filings, the total number of each respective Issuer's securities the Wylys beneficially owned, as well as the existence and extent of the Wylys' Form 4 filing delinquencies. As the Wylys well knew, each Issuer's annual reports, on Form 10-K, and proxy filings, on Schedule 14A, were required to include (I) a beneficial ownership table accurately reflecting the total number of shares beneficially owned by each of its directors and greater-than-5% shareholders and (2) disclosure of any delinquencies in its officers' and directors' Form 4 filings. By providing each of the Issuers, in response to periodic Questionnaires and ycar-end Form 5 certifications, false and materially misleading information about the number of shares they beneficially owned as well as the existence and extent of their Form 4 filing delinquencies, the Wylys caused the Issuers to incorporate that false information, either directly or by reference, in nearly every single Form 10-K and Schedule 14A the Issuers filed between 1992 and 2005. And although the Issuers included occasional footnote references, in their annual proxy filings' beneficial ownership tables, about the Issuer Securities the Wylys had recently transferred offshore, these footnotes were materially misleading in that they referred to the recipient Offshore Trusts as "independent," or they repeated the Wylys' false disavowal of beneficial ownership over those Offshore Trusts' holdings. 23 EFTA00316126  53. Attached as an Appendix arc charts listing the principal false and materially misleading SEC filings made or caused to be made by the Wylys. 54. By failing to claim and report their beneficial ownership over their offshore Issuer Securities, the Wylys materially underreported their true ownership percentages in all four of the Issuers. For example, in a Schedule I3D they filed on January 5, 1996, the Wylys claimed they beneficially owned 1,495,238 shares of common stock, or 5.6%, of Sterling Software's outstanding common stock. Had the Wylys included the shares held by their Offshore System, which they also controlled, they would have disclosed beneficially owning nearly 6 million shares of Sterling Software, which comprised over 22% of the company's outstanding common stock. Such dramatic discrepancies between the Wylys' actual and reported ownership of Issuer Securities were common during the course of their scheme- with their beneficial ownership reaching as high as 36.7% for Michaels, 33.7% for Sterling Software, and 16.1% for both Sterling Commerce and Scottish Re. Their reported ownership, by contrast, was frequently just half, a third, or even a fourth of what they actually held. THE WYLYS ALLOCATED THE ISSUER SECURITIES HELD IN THEIR OFFSHORE SYSTEM AMONG VARIOUS TRUSTS IN ORDER TO EVADE THE SEC'S DISCLOSURE REQUIREMENTS 55. The Wylys' evasion of the 13D requirements went beyond failing to report their own connection to their offshore Issuer Securities transactions and holdings. To further prevent the detection of their scheme, the Wylys created multiple Offshore Trusts and employed multiple Offshore Trustees, and then purposefully allocated their offshore Issuer Securities holdings among the different Offshore Trusts and Offshore Trustees, to ensure that no single trustee nominally held more than 5% of an Issuer's outstanding stock. Because the Wylys applied the fraudulent fiction that each of their Offshore 24 EFTA00316127 Trustees was the exclusive beneficial owner of the Issuer Securities that the Wylys nominally lodged with it, the Wylys' allocations significantly reduced, and ultimately eliminated outright, any Schedule 13D disclosures of the Wylys' offshore Issuer Securities holdings and transactions—even by components of their Offshore System. 56. Although their Offshore System as a whole held significant percentages of each of the Issuer's outstanding shares, the Wylys and the Protectors—including French strived to ensure that no single Offshore Trust or Offshore Trustee held greater than 5% of the outstanding shares of each of the Issuers and, except in a few circumstances, accomplished just that. By actively monitoring and managing each Offshore Trust's Issuer Securities holdings, the Wylys and the Protectors took steps to ensure that the Offshore Trusts and Trustees stayed below the reporting thresholds. These steps included: (1) allocating the Wylys' offshore Issuer Securities among numerous Offshore Trusts managed by numerous different trustees; (2) shuffling the administration of Offshore Trusts from one Offshore Trustee to another; and (3) structuring offshore transactions involving large amounts of Issuer Securities by dividing the Issuer Securities among different Offshore Companies administered by different Offshore Trustees. These machinationi were all performed solely to enable the Wylys to circumvent SEC reporting requirements and avoid public disclosure of their Offshore System's Issuer Securities holdings and trading. 57. In March 1995, for example, Sam Wyly instructed French to create a new Offshore Trust with a newly retained Offshore Trustee. Sam Wyly then had 350,000 Sterling Software shares transferred from one of his pre-existing Offshore Trusts ("Trust A") to the newly established Offshore Trust ("Trust B") "for no consideration." This 25 EFTA00316128 transfer reduced the Sterling Software holdings administered by Trust