The children of craft store kingpins Charles and Sam Wyly say they shouldn’t suffer for their fathers’ transgressions.

The U.S. Securities & Exchange Commission says they shouldn’t be allowed to spend the proceeds of the brothers’ fraud.

The offspring and other relatives of the Wyly brothers asked an appeals court in Manhattan last month to free their assets as the SEC tries to collect what a federal judge described as a “staggering” $300 million penalty.

A federal jury last year found that Sam and Charles Wyly, who helped build companies includingMichaels Stores Inc., perpetrated an offshore stock-trading fraud for 13 years that the SEC said yielded more than $550 million in illegal profits.

After the verdict, U.S. District Judge Shira Scheindlin ordered Sam Wyly and the estate of Charles, who was killed in a 2011 auto accident, to return $299.4 million, one of the largest such penalties against individual defendants. Sam Wyly and Caroline Wyly, Charles’s widow, filed for bankruptcy.

Seeking to preserve money, the SEC sought to freeze the assets of Wyly family members, saying they spent an illegally acquired fortune on private aircraft, clothing, cars, artwork, jewelry and a horse farm. With regulators arguing they might deplete resources needed to pay the fine, the judge extended an asset freeze in October to cover 16 people, including both men’s wives and 10 children.

Family’s Stance

The Wyly family is fighting back. The relatives contend they are innocent parties and that there’s no evidence they got proceeds of the fraud. Scheindlin’s order unfairly applies to “any asset that was acquired or commingled with funds received from the Wyly Brothers at any time during the past 10 years,” they say.

“There was no evidence at all that they received anything from the Wyly brothers’ offshore trusts,”David Kornblau, a lawyer for Wyly family members, told the appeals court. “It was a shotgun approach.”

Kornblau argued that if the Wyly brothers gave money to their children decades ago, the recipients shouldn’t have to return it now.

“It depends on the gift,” said Judge Rosemary Pooler, one of three hearing the case. “If it’s a bottle of perfume, perhaps you’re right, but if you’re gifted $23 million, perhaps you’re wrong.”

Personal Bank

The SEC says the relatives, as well as the brothers, used the gains from secret offshore transactions “as their own personal piggy bank.” The family doesn’t have a right to “assets of the defendants which are the ill-gotten gains, or are traceable to the ill-gotten gains, derived from the defendants’ fraudulent conduct,” it says.

“Judge Scheindlin said there needs to be a freeze to prevent the dissipation of assets by third parties,” Daniel Staroselsky, an SEC lawyer, told the appeals panel.

“The district court’s finding wasn’t a shotgun,” he said. “There was an afternoon of testimony about how the family benefited.”

Evidence of recent transfers cited by Scheindlin included one trust’s $27 million distribution to Charles Wyly’s children and the use of $10 million to establish a family trust in the Cook Islands.

Wyly family spreadsheets showed it had net assets of $1.4 billion in 2004, according to the SEC.

Bankruptcy Court

Family members last year argued that surrendering what the SEC sought would bankrupt them. And Sam Wyly in October filed his bankruptcy case in Dallas, followed days later by Caroline Wyly, who says she’s the 90 percent beneficiary of her late husband’s estate.

The SEC is now trying to collect the judgment through bankruptcy court.

Each of the Wyly relatives is allowed $15,000 a month for living expenses and items such as education, taxes and legal fees, under the freeze order.

The appeals panel, which also included judges Jose Cabranes and Christopher Droney, is to issue a decision at a later date.

The bankruptcy case is In re Samuel E. Wyly, 14-bk-35043, U.S. Bankruptcy Court, Northern District of Texas (Dallas). The SEC lawsuit is SEC v. Wyly, 10-cv-05760, U.S. District Court, Southern District of New York (Manhattan).