Opinion
IP 01-1168-C-K/T.
September 30, 2002
Entry On Motions To Dismiss
This Entry is a matter of public record and is being made available to the public on the court's web site, but it is not intended for commercial publication either electronically or in paper form. Although the ruling or rulings in this Entry will govern the case presently before this court, this court does not consider the discussion in this Entry to be sufficiently novel or instructive to justify commercial publication or the subsequent citation of it in other proceedings.
Hundred of unsuspecting investors placed their trust (and millions of dollars of their savings) in Heartland Financial Services, Inc. and some related companies. Unfortunately, their trust was betrayed by the unscrupulous principals of the Heartland entities. This case is part of the debris left behind as a result of the perfidious acts of a handful of scoundrels. Unfortunately for the investors, the legal theories upon which this case is based provide them no relief against the Defendants named in this suit. As will be explained below, the connection between the wrongdoers and these Defendants is slim, too tenuous as a matter of law to require them to repay what the Heartland thieves took.
Defendants have filed motions to dismiss. Plaintiff opposes the motions. Having reviewed the parties' briefs and heard oral argument, the court decides as follows.
I. Background
Following are the Complaint's allegations, which the court accepts as true for purposes of the motions to dismiss. Plaintiff, James A. Knauer, is the court-appointed receiver (the "Receiver") for Heartland Financial Services, Inc. ("Heartland"), an Indiana corporation, and JMS Investment Group, LLC ("JMS"), an Indiana limited liability company. Defendants, Jonathon Roberts Financial Group, Inc. ("Jonathon Roberts"), Alliance Capital Management Corporation ("Alliance"), Andover Securities, Inc. ("Andover"), FSC Securities Corporation ("FSC"), and FFP Securities, Inc. ("FFP"), at all times relevant were broker dealers registered under Section 15 of the Securities and Exchange Act ("SEA") and with the National Association of Securities Dealers.
Jonathon Roberts is the successor in interest to Alliance and Andover is the predecessor to Andover Brokerage, L.L.C. and Andover Brokerage Corporation (collectively "Andover Brokerage").
Kenneth R. Payne was a licensed securities registered representative with Defendants for the following time periods: Andover — December 12, 1991 to January 1, 1996; FSC — January 1, 1996 to February 14, 1997; FFP — February 26, 1997 to October 1, 1998; Jonathon Roberts — March 15, 1999 to August 10, 2000; and Alliance — March 15, 1999 to unknown date. Daniel G. Danker was a licensed securities registered representative with Defendants for the following time periods: Andover — October 28, 1991 to January 1, 1996; FSC — January 1, 1996 to February 14, 1997; FFP — February 26, 1997 to October 1, 1998; Jonathon Roberts — March 12, 1999 to March 27, 2000; Alliance — March 15, 1999 to unknown date. During these time periods, Payne and Danker were employees and agents of Andover, FSC, FFP, Jonathon Roberts, and Alliance (collectively the "Broker Dealers"). Each Broker Dealer was able to control Payne and Danker during the time period in which they maintained their securities licenses with such Broker Dealer. (Compl. ¶ 35.)
Heartland was founded by Payne and holds itself out as a brokerage, insurance and estate planning firm. Payne owns and was the president of Heartland. Heartland was not registered with the United States Securities and Exchange Commission ("SEC"). JMS was founded in 1997 by Johann M. Smith. Smith was the manager of and attorney for JMS and made the investment decisions for JMS. Danker was the vice president and office manager of Heartland. He maintained Heartland's books and records. Constance Brooks-Kiefer was an administrative assistant at Heartland. She was responsible at both Heartland and JMS for preparing and issuing checks, depositing investor funds, preparing and issuing account statements, and maintaining the books and records.
Beginning in 1994 and continuing through August 2001, Payne, Danker, Smith, Brooks-Kiefer, Heartland, JMS and others engaged in a fraudulent Ponzi scheme in which "induced investors to pay them millions of dollars through the fraudulent sale of securities (the Ponzi Scheme)." (Compl. ¶ 24; SEC Compl. ¶ 1.) Investors were told that their investments would be used to purchase securities and were promised a high rate of return. Payne and Danker sold the securities without registration under the SEA and in violation of the SEA and the Indiana Securities Act. Investors were sent fraudulent confirmations and monthly statements on Heartland letterhead and/or that of Heartland's alter ego entities which indicated the investments were earning high rates of return.
Most investor funds in Heartland and JMS were deposited into an account in the name of Lincoln Fidelity Escrow (the "Lincoln account") and commingled with other investor funds. Smith and Brooks-Kiefer are the signatories on the Lincoln account. Some investor funds were deposited directly into Payne's bank account; some investor funds were transferred from the Lincoln account to Heartland's corporate account. Payne and Danker are signatories on Heartland's account. Though a limited amount of investor funds in Heartland, JMS and other related entities were used to purchase securities, most investments were never made and were used in the Ponzi scheme and/or to pay the personal and business expenses of Heartland, JMS, Payne, Danker, Smith, and Brooks-Kiefer. Payne, Danker, Smith and Brooks-Kiefer wrongfully converted Heartland funds to their own use and personal benefit or to that of others. Also, assets of Heartland and JMS were fraudulently transferred to a number of persons and other entities controlled by Payne, Danker, Smith, Brooks-Kiefer and others. Danker has been convicted of wire fraud and money laundering. Payne has been convicted of mail fraud and money laundering.
The investors were induced by the fraud and deceit of Payne and Danker. The investors believed that Payne and Danker were acting with the knowledge, consent and approval of the Broker Dealers and that the investments offered by Payne and Danker were approved and authorized by the Broker Dealers. No Broker Dealer notified the investors "to whom Payne and Danker fraudulently sold securities that Payne and/or Danker were not authorized to offer and sell such securities." (Compl. ¶ 46.)
It is alleged that "Payne, Danker and the Broker/Dealers owed a fiduciary duty to each of the investors and to Heartland and JMS to act honestly and openly and in good faith in the conduct of their affairs and in handling investor funds." (Id. ¶ 49.) They breached this fiduciary duty "when, among other things, Payne and/or Danker commingled funds invested, . . . converted funds in bank accounts and other invested funds to their own use and benefit, fraudulently misrepresented the value of securities and how investor funds would be invested or used and when the Broker Dealers failed to exercise adequate and reasonable oversight over the conduct of Payne and Danker." (Id. ¶ 50.)
The Broker Dealers, as licensed securities broker dealers, had a duty to supervise, monitor and control the securities sales activities of Payne and Danker, including the duty to ascertain what securities they were selling, the handling of the proceeds of such sales, and whether Payne and Danker were engaging in other business activity. (Id. ¶ 60.) This duty was owed to those persons to whom Payne and Danker sold securities and to Heartland and JMS; and the Broker Dealers breached this duty, causing the losses to the investors and the losses and liabilities of Heartland and JMS. (Id. ¶¶ 61-63.)
The Complaint designates the paragraph as 23, but this appears to be a typographical error.
The Complaint incorporates by reference the 95 rhetorical paragraphs of the complaint filed against Payne, Danker and others in the case of United States Securities and Exchange Commission v. Payne, Cause No. IP00-1265-C-T/G (the "SEC Complaint"). (Compl. ¶ 26.) The Complaint also incorporates by reference rhetorical paragraphs 41 through 206 of the complaint filed by the Receiver against Payne, Danker and others in Knauer v. Payne, Cause No. IP00-1629-C-T/G (the "RICO Complaint"). (Compl. ¶ 27.)
The SEC Complaint alleges that Heartland and JMS engaged in acts which violated federal securities laws and made false and misleading statements and knew or were reckless in not knowing about the Ponzi scheme including the false and misleading statements of Heartland, JMS, Payne, Danker, and Brooks-Kiefer. (See, e.g., SEC Compl. ¶¶ 4-5, 72-74, 76-77, 79-81, 82-86, 89-93.) The SEC Complaint further alleges, inter alia, that all investor funds were deposited in the Lincoln account (id. ¶¶ 21, 57), JMS never purchased the promised stocks or purchased only a limited number of shares to show investors and the remaining funds were deposited into the Lincoln account and commingled with funds from the other investment schemes, (id. ¶ 35). In addition, it is alleged that Heartland investor money was not deposited into the Heartland bank account (id. ¶ 55) and most of that money was commingled with other investor funds in the Lincoln account, which account was used to operate the Ponzi scheme and allocated to Payne, Danker, Smith, Brooks-Kiefer, Heartland, JMS, and for travel, entertainment and clothing allowances for employees, (id. ¶¶ 51, 62, 63). The SEC Complaint also alleges that investor money was deposited directly into Payne's banking account; only a small percentage of all money deposited into the Lincoln and Payne accounts and transferred to the Heartland account was used to purchase legitimate securities; and much of the money deposited into the Heartland account was used to pay Payne and his personal expenses, paid to Smith or converted to cash. (Id. ¶¶ 59-65.) The SEC Complaint alleges that "JMS and Heartland knew, or were reckless in not knowing, of the activities described in Paragraphs 89 [which realleges and incorporates by reference paragraphs 1 through 65] through 91 above." (SEC Compl. ¶ 92; see also id. ¶¶ 70-73, 78-80.)
Count I of the Receiver's Complaint in this case alleges that the Broker Dealers were "controlling persons" under the SEA and the Indiana Securities Act, Indiana Code § 23-2-1-19(d), and are therefore liable for the associated wrongful conduct of Payne and Danker pursuant to Section 20 of the SEA and the Indiana Securities Act. Count II alleges that the Broker Dealers were "controlling persons" and thus liable for the sale of unregistered, non exempt securities by Payne and Danker pursuant to Section 15 of the SEA and Indiana Securities Act. Count III alleges that the Broker Dealers are "directly liable to each investor and to Heartland and JMS for breach of fiduciary duty and fraud" (Compl. ¶ 51) and are liable "for the fraudulent and wrongful conduct of Payne and Danker . . . under the doctrine of respondeat superior." (Id. ¶ 52.) Count IV is brought under Indiana's civil actions by crime victim statute and alleges that the Broker Dealers conducted or participated directly or indirectly in the commission of several criminal acts in violation of state law which caused pecuniary loss to Heartland, JMS and their investors. Count V alleges that the Broker Dealers negligently supervised the securities sales activities of Payne and Danker.
II. Discussion
The Broker Dealers move pursuant to Rules 12(b)(1) and 12(b)(6) to dismiss the Complaint for lack of subject matter jurisdiction, contending that the Receiver lacks standing. They also argue that the Receiver's claims are barred under the doctrine of in pari delicto. FSC contends that the Receiver's claims against it on behalf of JMS must be dismissed because JMS did not exist until the affiliation of Payne and Danker with FSC had ceased. The Broker Dealers offer several other arguments in support of their motions, but the court need not reach them here for reasons that become apparent in this entry.
A. Legal Standard Under Rules 12(b)(1) and 12(b)(6)
In ruling on a Rule 12(b)(1) motion to dismiss for lack of standing, the court accepts as true the factual allegations of the complaint, construes the complaint in favor of the plaintiff, Perry v. Village of Arlington Heights, 186 F.3d 826, 829 (7th Cir. 1999); Am. Fed'n of Gov't Employees, Local 2119 v. Cohen, 171 F.3d 460, 465 (7th Cir. 1999), and considers whether relief is possible under any set of facts that could be established consistent with the complaint, Cohen, 171 F.3d at 465.
Similarly, a Rule 12(b)(6) motion to dismiss should not be granted "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957). A plaintiff is not required to plead the facts or elements of a claim, unless the claim falls within the exceptions in Rule 9. Swierkiewicz v. Sorema, N.A., 534 U.S. 506, ___, 122 S.Ct. 992, 998 (2002); Walker v. Thompson, 288 F.3d 1005, 1007 (7th Cir. 2002). However, if a plaintiff "`plead[s] particulars, and they show he has no claim, then he is out of luck — he has pleaded himself out of court.'" Jefferson v. Ambroz, 90 F.3d 1291, 1296 (7th Cir. 1996) (quoting Thomas v. Farley, 31 F.3d 557, 558-559 (7th Cir. 1994)) (alteration added). The same as with a Rule 12(b)(1) motion, in ruling on a 12(b)(6) motion, the court views the complaint in the light most favorable to the plaintiff and accepts the complaint's allegations as true. Doherty v. City of Chicago, 75 F.3d 318, 322 (7th Cir. 1996).
B. The Receiver's Standing
The first issue is whether the Receiver has standing to bring the claims asserted in this case. The party invoking the federal court's jurisdiction bears the burden of establishing standing. Perry v. Village of Arlington Heights, 186 F.3d 826, 829 (7th Cir. 1999). At the pleading stage, general factual allegations of injury resulting from the defendant's conduct may suffice for purposes of establishing standing. Family Children's Ctr., Inc. v. Sch. City of Mishawaka, 13 F.3d 1052, 1058 (7th Cir. 1994).
The Receiver lacks standing to assert claims on behalf of the defrauded investors and has standing to assert claims on behalf of the receivership entities, namely Heartland and JMS. See Caplin v. Marine Midland Grace Trust Co. of New York, 406 U.S. 416, 429 (1972); Scholes v. Lehmann, 56 F.3d 750, 754-55 (7th Cir. 1995). In Scholes v. Schroeder, 744 F. Supp. 1419 (N.D.Ill. 1990), the court relying on Caplin said that "a receiver or like surrogate cannot pursue claims that belong, not to the receivership estate as such, but rather to those who may have an ultimate derivative interest in the estate." Id. at 1422. In that case, a receiver, Steven Scholes, brought suit on behalf of corporations in receivership, asserting inter alia federal securities claims under § 10(b) and Rule 10b-5 and common law fraud, emphasizing the injury to investors. Id. at 1423-24. The court held that the receiver could not bring claims on behalf of investors in the corporate entities. Id. at 1422. The court explained:
Fraud on investors that damages those investors is for those investors to pursue — not the receiver," and "by contrast, fraud on the receivership entity that operates to its damage is for the receiver to pursue (and to the extent that investors as the holders of equity interests in the entity may ultimately benefit from such pursuit, that does not alter the proposition that the receiver is the proper party to enforce the claim).
Id. (emphasis in original).
The Seventh Circuit applied the same rule in Troelstrup v. Index Futures Group, Inc., 130 F.3d 1274 (7th Cir. 1997), in which the Commodity Futures Trading Commission sued John Tobin, a trader alleged to have defrauded investors. At the Commission's request, the court appointed John Troelstrup as Tobin's receiver. Troelstrup filed a claim against a registered futures commission merchant through which Tobin had traded on behalf of four commodities trading accounts (hereinafter referred to as the Phoenix Pharynol account) established by Tobin with the merchant. Troelstrup alleged that the merchant's negligence facilitated Tobin's fraud. Id. at 1275-76. The Seventh Circuit held that the receiver lacked standing to sue on behalf of the Phoenix Pharynol account or the investors "because he was not their receiver." Id. at 1277 (emphasis in original).
Thus, the question is whether the claims asserted by the Receiver are claims of the investors or Heartland and JMS. The Broker Dealers argue that the claims are of the investors, whereas, the Receiver argues the claims are of Heartland and JMS. Neither side gets it completely right; the answer is that some of the claims alleged are claims of the investors and others are of Heartland and JMS.
The Complaint alleges that Payne and Danker engaged in a fraudulent and deceptive Ponzi scheme in connection with the sale of securities to the investors that violated federal and state securities laws. The Broker Dealers contend that the securities claims asserted in Counts I and II fail because there is no injury to Heartland or JMS from the securities transactions. In response to the challenges to his standing, the Receiver shifts the theories and focus of his Complaint from the injury to the defrauded investors to the injury to Heartland and JMS. Though there ultimately are sufficient allegations in the Complaint to support this shift in theories, the court is required to ignore the vast majority of the allegations in the Complaint which focus on the rights of and injury to the defrauded investors, which, despite the Receiver's position, appear to be more than mere background allegations.
At oral argument in direct response to a question by the court, counsel for the Receiver conceded that the harm to Heartland and JMS came not from the sales of securities but from the conversion of the funds of Heartland and JMS by Payne and Danker. This concession and the relevant case law cited above dictate the conclusion that the Receiver lacks standing to maintain the federal and state securities claims asserted in Counts I and II.
In his response brief, the Receiver maintains that the decisions in the Scholes cases support the conclusion that he has standing to pursue the claims of Heartland and JMS against the Broker Dealers, see Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995), cert. denied, African Enterp., Inc. v. Scholes, 516 U.S. 1028 (1995); Scholes v. African Enterp., Inc., 838 F. Supp. 349 (N.D.Ill. 1994); Scholes v. Stone, McGuire Benjamin, 821 F. Supp. 533 (N.D.Ill. 1993). Though these decisions may lend support to the Receiver's claim to standing to assert claims for breach of fiduciary duty, fraud, negligent supervision, and action by a crime victim, none supports his claim to standing to bring the securities claims.
Lehmann and African Enterprises involved fraudulent conveyance claims, and the courts concluded that the unauthorized removal of assets from the corporations caused injury to the corporations. Lehmann, 56 F.3d at 754; African Enterp., 838 F. Supp. at 353. Stone, McGuire involved legal malpractice, negligence and breach of fiduciary duty claims against the attorneys and law firm for the schemer and the receivership entities, and there was a factual issue regarding the damages to the entities caused by the defendants' alleged conduct. 821 F. Supp. at 537.
The Receiver submits that Congress has given federal receivers broad authority to pursue claims of the receivership entities, citing 28 U.S.C. § 754 and 28 U.S.C. § 959 as support. Those statutes authorize a receiver appointed by a federal court to sue and be sued. Section 959 also provides that a receiver appointed by a federal court is to "manage and operate" the receivership estate "according to the requirements of the valid laws of the State in which such property is situated, in the same manner that the owner or possessor thereof would be bound to do if in possession thereof." 28 U.S.C. § 959(b). Neither statute authorizes a receiver to pursue claims other than claims on behalf of the receivership entity, so neither supports the Receiver's position that he has standing to maintain the securities claims.
The Receiver submits in his response brief that Indiana receivership law provides authority for him to pursue the claims of Heartland and JMS against the Broker Dealers. Under Indiana law, the general rule is "that the receiver of an insolvent corporation has no greater rights than those possessed by the corporation itself." Iglehart v. Todd, 178 N.E. 685, 690 (Ind. 1931). While it is true that a receiver may collect assets of the receivership entity for the benefit not only of the entity but also its creditors, see Marion Trust Co. v. Blish, 84 N.E. 814, 816 (Ind. 1908), the receiver can maintain only those actions that the receivership entity could maintain in its own name, id. at 816 (stating that the receiver "takes only the rights of the corporation, such as could be asserted in his own name, and upon that basis only can he litigate for the benefit of either shareholders or creditors, except when acts have been done in fraud of the rights of the latter, but which are valid as against the corporation itself, in which case he holds adversely to the corporation") (citation omitted). None of the Indiana authorities relied on by the Receiver supports his claim to standing to pursue the federal or state securities claims under the circumstances presented in the instant case.
The court concludes that the Receiver lacks standing to maintain the federal and state securities claims in Counts I and II because those claims assert an alleged injury not to Heartland or JMS but only to the investors. Thus, such claims are brought on the investors' behalf rather than on behalf of Heartland or JMS. Indeed, the wrongs alleged in Counts I and II benefitted rather than injured Heartland and JMS: The fraudulent securities transactions brought money into those entities. The Receiver was not appointed receiver for the investors and, therefore, lacks standing to assert claims on their behalf. As a result, the securities claims will be dismissed pursuant to Rule 12(b)(1). The state law claims for breach of fiduciary duty, fraud, negligent supervision, and civil action by a crime victim, however, are premised not only on the alleged wrongful securities transactions but also on the wrongful conversion of the funds and assets of Heartland and JMS, which caused an injury to these entities. Thus, the court concludes that the Receiver has standing to assert these state law claims.
C. In Pari Delicto
Because the Receiver has standing to maintain some of the claims asserted in this case, the court now turns to the Broker Dealers' contention that the Receiver's claims against them are barred by the doctrine of in pari delicto. The Latin phrase "in pari delicto" means "of equal fault." Theye v. Bates, 337 N.E.2d 837, 844 (Ind.Ct.App. 1975) (citing Perma Life Mufflers, Inc. v. Int'l Parts Corp., 392 U.S. 134, 135 (1968)). The doctrine is premised upon the equitable principle that "[n]o Court will lend its aid to a man who founds his cause of action upon an immoral or illegal act," In re Dow, 132 B.R. 853, 860 (Bankr.S.D.Ohio 1991). Under the doctrine a plaintiff may not maintain a claim against a defendant if the plaintiff bears fault for the claim. Official Committee of Unsecured Creditors v. R.F. Lafferty Co., Inc., 267 F.3d 340, 354 (3rd Cir. 2001).
The Broker Dealers assert that Indiana law governs the Receiver's authority to maintain the claims against them. Neither Indiana's Supreme Court nor Indiana's appellate courts have addressed whether in pari delicto is applicable under the circumstances presented in this case. However, the applicability of in pari delicto may depend on whether the wrongful conduct of Payne and Danker can be imputed to Heartland and JMS and, thus, the Receiver. See R.F. Lafferty Co., 267 F.3d at 355; In re Walnut Leasing Co. v. Shapiro, No. 99-526, 1999 WL 729267, at *4 (E.D.Pa. Sept. 8, 1999). Imputation with respect to the state law claims is controlled by state law. See O'Melveny Myers v. FDIC, 512 U.S. 79, 84-85 (1994) (holding in the FDIC receivership context that state law "governs the imputation of knowledge to corporate victims of alleged negligence"); Schacht v. Brown, 711 F.2d 1343, 1347 (7th Cir. 1983) (explaining that the analysis in Cenco Inc. v. Seidman Seidman, 686 F.2d 449 (7th Cir. 1982), of the circumstances in which knowledge of fraud of the corporation's directors could be imputed to the corporation was "merely an attempt to divine how Illinois courts would decide that issue.").
The court, however, need not consider whether the knowledge of Payne or Danker may be imputed to Heartland and JMS. The Complaint expressly alleges that Heartland and JMS participated in the Ponzi scheme and had knowledge of the fraudulent activities of Payne and Danker involving the deposit of investor funds in the Lincoln account, the commingling of investor funds, and the misuse of the funds of Heartland and JMS and the Lincoln account to operate the Ponzi scheme and pay Payne, Danker, Smith, Brooks-Kiefer, Heartland, JMS. Thus, even when read liberally and with all reasonable inferences drawn in the Receiver's favor, the Complaint leads to the inescapable conclusion that Heartland and JMS participated in the Ponzi scheme and knew of the conversion of Heartland and JMS funds by Payne, Danker and others. The court concludes that the Receiver has pled allegations which reveal that his remaining claims against the Broker Dealers are barred by the doctrine of in pari delicto. The court is sensitive that in pari delicto is an affirmative defense and generally dependent on the facts, so often not an appropriate basis for dismissal. However, where, as here, the plaintiff has pled facts that conclusively show his fault for the claim or claims asserted, dismissal is proper.
Moreover, Indiana law on imputation as applied to this case leads to the conclusion that the Receiver's remaining claims are barred. An agent's knowledge generally is imputed to the principal. See, e.g., Southport Little League v. Vaughn, 734 N.E.2d 261, 274 (Ind.Ct.App. 2000), trans. denied. However, "[a]n agent's knowledge will not be imputed to the principal where the agent's conduct creates a presumption that the agent would not communicate his knowledge. Mid-Continent Paper Converters, Inc. v. Brady, Ware Schoenfeld, Inc., 715 N.E.2d 906, 910 (Ind.Ct.App. 1999). This exception to the general rule is known as the adverse interest exception. See, e.g., First Nat'l Bank of Cicero v. Lewco Secs. Corp., 860 F.2d 1407, 1417 (7th Cir. 1988). When an agent acts to defraud the principal, it cannot be presumed that the agent would have disclosed his knowledge of fraud to the principal. See id.; Mid-Continent Paper, 715 N.E.2d at 909-10. There is an exception to the exception. "Where an adverse agent is also the sole representative of the principal in the transaction in question, the principal may once again be charged with the agent's knowledge." First Nat'l Bank of Cicero, 860 F.2d at 1417 (citation omitted); see also In re Dublin Secs., Inc., 133 F.3d 377, 380 (6th Cir. 1997) ("where the principal and agent are one and the same . . . [the sole actor exception] imputes the agent's knowledge to the principal . . . because the party that should have been informed was the agent itself albeit in its capacity as principal.").
The Complaint's allegations reveal that the wrongful conduct of Payne and Danker should be imputed to Heartland and JMS. Payne is the founder, owner and president of Heartland. Danker was the vice president and office manager of Heartland. Smith is the founder, manager and attorney of JMS. Payne and Danker are signatories on Heartland's account, and Smith and Brooks-Kiefer are the signatories on the Lincoln account. The Receiver concedes that Heartland and JMS were dominated and operated by Payne and Danker. (See Receiver's Resp. Br. at 31.) Payne and Danker were Heartland and along with Smith and Brooks-Kiefer were JMS. There is no one else involved in the management or control of Heartland or JMS who was innocent of wrongdoing. Simply put, Payne, Danker, Smith and Brooks-Kiefer were Heartland and JMS.
The case of Dublin Securities 6th Cir. 1997), supports the conclusion that the doctrine of in pari delicto applies in this case to bar the Receiver's remaining claims. There, the debtor corporation had engaged in fraudulent securities transactions. The debtor corporation's bankruptcy trustee brought state law claims of negligence, breach of fiduciary duty, negligent misrepresentation, recklessness, common law fraud, and the right of contribution against a law firm and its attorneys who had represented the debtor corporation. The Sixth Circuit affirmed the district court's dismissal based on in pari delicto. Dublin Secs., 133 F.3d at 379. The court reasoned that although the individual officers and directors acted adversely to the corporation's interest, the trustee recognized that they "so dominated and controlled the corporations that the corporation had no separate mind, will, or existence of its own." Id. at 380. The court concluded that the officers and directors were the "alter egos" of the debtor corporations and, therefore, their malfeasance was directly attributable to the debtor corporations. Id. So, too, here. Though Payne and Danker acted adversely to the interests of Heartland and JMS in converting their funds and assets, even the Receiver acknowledges that Heartland and JMS were dominated and controlled by Payne and Danker. (See Receiver's Resp. Br. at 31 (stating that Heartland and JMS were "dominated by and operated by Payne and Danker for the purpose of engaging in transactions adverse to themselves")). Thus, Dublin Securities lends support to the conclusion that in pari delicto applies to bar the Receiver's remaining claims.
The Receiver relies heavily on Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995) in support of his position that in pari delicto is inapplicable as against his claims. In that case, one Michael Douglas created three corporations and caused them to create limited partnerships in which the corporations would be general partners and sell limited-partner interests to investors. Douglas engaged in a Ponzi scheme. The SEC sued Douglas and the three corporations and requested the appointment of a receiver for Douglas and the corporations. The court appointed Steven Scholes. Scholes, 56 F.3d at 753. Scholes sued Douglas's ex-wife, her husband, an investor in the Ponzi scheme who made money, and five religious corporations to recover assets allegedly fraudulently conveyed to them. Id. at 753-54.
The Scholes court recognized the rule that the maker of a fraudulent conveyance and those in privity with him were bound by it. 56 F.3d at 754. The reason for this rule is that the wrongdoer should not be allowed to profit from his wrong. The court said that the rule was inapplicable because a receiver had been appointed for the corporations and Douglas no longer had control of or an interest in them. The court wrote:
The appointment of the receiver removed the wrongdoer from the scene. The corporations were no more Douglas's evil zombies. Freed from his spell they became entitled to the return of the moneys — for the benefit not of Douglas but of innocent investors — that Douglas had made the corporations divert to unauthorized purposes.
. . . [T]he defense of in pari delicto loses its sting when the person who is in pari delicto is eliminated. . . .[W]e cannot see an objection to the receiver's bringing suit to recover corporate assets unlawfully dissipated by Douglas.
Id. at 754 (citations omitted). The court concluded that the receiver could sue to recover the corporate assets fraudulently conveyed by Douglas. Id. at 755.
Scholes v. Lehmann is not on all fours with the instant case, however. There, the court allowed the receiver to pursue claims for fraudulent conveyances. In the court's view, the context in which the court held in pari delicto inapplicable matters. The Receiver in this case has not brought a fraudulent conveyance claim. Therefore, the court finds that Scholes v. Lehmann does not preclude the application of in pari delicto in this case.
The court's view that context matters finds even more support when considered in light of the applicable substantive law. Under Indiana law "the general rule is that a receiver cannot have . . . any right of action not vested in the debtor[.]" State ex rel. Shepard v. Sullivan, 21 N.E. 1093, 1093 (Ind. 1889); see also Igelhart v. Todd, 178 N.E. 685, 690 (Ind. 1931) ("the general rule . . . is that the receiver of an insolvent corporation has no greater rights than those possessed by the corporation itself, and a defendant in a suit brought by him may take advantage of any defense that might have been made if the suit had been brought by the corporation"); Marion Trust Co. v. Blish, 84 N.E. 814, 816 (Ind. 1908) (stating that "There can be no doubt . . . that it is the general rule that in the ordinary receivership . . ." the receiver is subject to all equities and defenses available against the receivership entity). The only true exception to this rule is that a receiver has a right to sue to set aside a fraudulent conveyance. See, e.g., Blish, 84 N.E. at 816-17; State ex rel. Shepard, 21 N.E. at 1093. The exception is inapplicable in this case. Thus, Indiana law provides that any defense available as against Heartland or JMS is available as against the Receiver. In pari delicto would bar claims by Heartland and JMS against the Broker Dealers for fraud, breach of fiduciary duty, negligent supervision, and civil action by a crime victim. Consequently, the court concludes that in pari delicto bars these claims by the Receiver against the Broker Dealers.
D. Claims Against FSC On Behalf of JMS
FSC contends that all of the Receiver's claims against FSC on behalf of JMS must be dismissed because such claims are based on derivative liability or respondeat superior and JMS did not come into existence until after Payne and Danker had ended their affiliation with FSC. Though the Receiver did not oppose this aspect of FSC's motion to dismiss in its response brief, at oral argument he argued that FSC could be held liable for the conduct of Payne and Danker which caused harm to JMS because FSC failed to prevent the Ponzi scheme from continuing.
The court disagrees that there is any set of facts consistent with the allegations of the Complaint upon which the Receiver could hold FSC liable for any alleged injury to JMS. The Receiver's argument is contrary to the Complaint's express allegations that a Defendant had the ability to control Payne and Danker during the time period in which Payne and Danker were licensed with the Defendant. (Compl. ¶ 23 (alleging that during the time periods in which Payne and Danker were acting as licensed securities dealers, employees, agents of the Broker Dealers, the Broker Dealers had the ability to control the actions of Payne and Danker in connection with the offering and sale of securities and other business activities in connection with securities transactions), ¶ 35 (alleging each defendant controlled Payne and Danker during the time period in which they were employees and/or agents of that defendant and during the time period in which Payne and Danker maintained their securities licenses with said defendant), ¶ 36 (alleging each defendant had a duty to monitor the conduct of Payne and Danker and conduct appropriate oversight over them during the period in which they held licenses with said defendant); see also Compl. ¶¶ 56 62). The Complaint alleges that JMS came into existence in October 1997 and that Payne's and Danker's affiliation with FSC ended before that time. Thus, there is no legal basis for holding FSC liable to JMS for any of the wrongful acts of Payne or Danker. This is yet another reason why the Receiver's claims asserted on behalf of JMS against FSC should be dismissed.
III. Conclusion
For the foregoing reasons, the court finds that the motions to dismiss should be GRANTED and the securities claims should be dismissed pursuant to Rule 12(b)(1) for lack of standing and the remaining claims should be dismissed pursuant to Rule 12(b)(6) as barred by the doctrine of in pari delicto.
There is just one remaining matter. Defendant Andover has not appeared in this case. At oral argument, counsel for the Receiver agreed that the time for service had long expired and indicated Andover could be dismissed without prejudice. The court treats this as a motion for the dismissal of Andover, and will GRANT same.
An appropriate judgment will be entered.
Again, the result is yet another unfortunate set back for the investors, but it is the inevitable result under the law.
ALL OF WHICH IS ORDERED this 30th day of September 2002.