SEC Temporary Asset Freeze Not Barred By Automatic Stay Provisions

In an effort to protect the property of a bankruptcy estate, Section 362(a) of the U.S. Bankruptcy Code imposes an automatic stay on most proceedings against a debtor in bankruptcy. The policy of this section is to grant relief to a debtor from creditors, and to prevent a "disorganized" dissipation of the debtor's assets. (See, e.g., U.S. Securities and Exchange Commission v. Brennan, 230 F.3d 65, 70 (2d Cir. 2000).) However, the scope of the automatic stay is not all-encompassing. For example, Section 362(b) provides several exceptions, including one for "the commencement or continuation of an action or proceeding by a governmental unit ... to enforce such governmental unit's ... police and regulatory power." This rather straightforward exception to the automatic stay is nevertheless qualified by a carve-out—often referred to as "the exception to the exception"—that maintains the automatic stay where such governmental police action occurs in connection with the enforcement of a money judgment. In Securities and Exchange Commission v. Wyly, 2014 U.S. Dist. LEXIS 155382 (S.D.N.Y. 2014), the U.S. District Court for the Southern District of New York considered whether a temporary asset freeze sought by the U.S. Securities and Exchange Commission was excepted from the automatic stay as a governmental exercise of police powers, or whether such action was within the "exception to the exception" and thus barred by the automatic stay.

Wyly involved a civil enforcement action brought by the SEC against Sam Wyly and the estate of his late brother, Charles Wyly, arising from a fraudulent offshore securities scheme. In early October 2014, the SEC requested that the district court enter a pretrial order for a temporary asset freeze, financial discovery, and an accounting of the Wyly brothers' assets in order to preserve the SEC's ability to enforce a final judgment, which the SEC was pursuing but had yet to secure. Sam Wyly and Charles Wyly's estate representative, along with various other Wyly family members, opposed the SEC's request. Later that month, however, while the SEC's application to the district court was still pending, Sam Wyly filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Northern District of Texas. Charles Wyly's widow and primary estate beneficiary filed a similar petition for relief four days later.

As a result of the bankruptcy filings, the Wylys claimed that the SEC was barred from freezing any assets...