Spring 2011 • Issue 39, page 20

A Review of Seminal Decisions Impacting Regulatory Receivership Estates' Scope and Aggregation of Assets

By Caris, Gary Owen & Hawes, Lesley Anne*

[Editor’s note: These materials are excerpted from a more extensive examination of these issues presented at the California Receivers Forum’s “Loyola IV” seminar earlier this year. A complete video of the 24 panel presentations and set of all written materials is available by contacting tspangler@jbsassociates.ws]

These are selected cases addressing three principal issues: (1) the scope of the receivership estate, including the extent to which assets of non-receivership parties and third parties may be frozen or become part of the receivership; (2) jurisdictional issues associated with the pursuit of receivership assets; and (3) plans for the distribution of receivership assets, including the treatment of claims of defrauded investors or injured consumers in relation to other types of creditors of the receivership entities, such as pre-receivership vendor claims.

Scope of Receivership and Application to Non-parties
In re San Vicente Medical Partners, Ltd. (Securities and Exchange Commission v. American Principals Holding, Inc.), 962 F. 2d 1402 (9th Cir. 1992)
In a civil enforcement action by the SEC, the District Court issued an order appointing a receiver over the only named defendant in the action, a corporation known as American Principals Holding, Inc. (“APHI”). The receivership order appointed the Receiver over “’all funds, assets, choses in action and other property belonging to, or in the possession or control of, defendant [APHI] and its subsidiaries . . . .’” APHI and its subsidiaries were the general partners in or trustees of numerous limited partnerships. San Vicente Medical Partners, Ltd. (“San Vicente”) was one of those limited partnerships over which the Receiver took control and which the Receiver subsequently placed in bankruptcy. Two of the issues addressed by the Ninth Circuit on appeal were the extent to which the receivership order covered San Vicente as a receivership entity and even if the scope of the order was broad enough to encompass San Vicente, whether the District Court had the authority to extend the receivership to cover San Vicente’s assets as a non-party to the SEC action.

The Ninth Circuit affirmed the District Court’s conclusions that the receivership order was intended to cover the limited partnerships under the control of APHI. In so ruling, the Court stated while the order did not specifically name the limited partnerships, including San Vicente, the language of the receivership order provided that the receivership covered all assets and property controlled by APHI and its subsidiaries, and since one of the APHI subsidiaries was the general partner that controlled San Vicente, the Court concluded “the receivership incorporates the funds and assets of San Vicente.”

The Ninth Circuit also held that the District Court had the legal authority to exercise quasi in rem jurisdiction over the assets of San Vicente to bring its assets within the scope of the receivership and the exercise of such jurisdiction under the facts of that case was consistent with principles of due process. Bringing the assets of San Vicente within the scope of the receivership resulted in the District Court exercising “control over the property of a legal entity not before the court.” In re San Vicente Medical Partners, Ltd., 962 F. 2d at 1406. San Vicente challenged the District Court’s exercise of authority over its assets on due process grounds, including whether the District Court could properly exercise authority under the constitutional standards set forth in the United States Supreme Court’s International Shoe decision and whether San Vicente’s procedural due process rights to notice and an opportunity for hearing were violated based on the fact it was not a named party in the SEC action. The Ninth Circuit rejected these claims, finding that there were sufficient “minimum contacts” between San Vicente and the forum where the action was pending since it was a California limited partnership with its principal place of business in the state where the SEC action was pending.

The Court specifically noted that even though San Vicente was not named a party, it received actual notice of the receivership proceedings because its general partner, which was a subsidiary of APHI, had notice of the proceedings, and the District Court’s order to show cause concerning the appointment of a permanent receiver was specifically directed to the subsidiaries of APHI.

Securities and Exchange Commission v. Hickey, 322 F. 3d 1123 (9th Cir. 2003)
In this case, the Ninth Circuit affirmed the extension of the District Court’s asset freeze in connection with a civil enforcement proceeding to include the assets of a non-party entity which was at least nominally owned by the individual defendant’s mother, not by the individual defendant himself. The Ninth Circuit analyzed the extent to which the District Court could properly extend the asset freeze against the named defendant to reach the assets of the non-party entity owned by a third party. The Ninth Circuit held that the SEC in the Hickey case could not demonstrate that the third party entity was the alter ego of the defendant since the defendant had no ownership whatsoever in the entity, a factor the Ninth Circuit found to be an essential prerequisite to an alter ego determination under California law. However, the Court held the extension of the asset freeze was nevertheless proper under the District Court’s inherent authority to issue orders for equitable remedies and “ancillary relief” necessary to effectuate relief in securities fraud actions. In Hickey, the District Court had entered judgment against the individual defendant, the individual defendant had agreed to make monthly payments to the SEC as part of that judgment and the source of the monthly payments was to be the income from the third party entity over which the SEC sought to extend the asset freeze. The Ninth Circuit held that “the district court was authorized to freeze the assets of the Brokerage, so long as doing so was necessary to protect and give life to the disgorgement and contempt orders already entered against Hickey.” Securities and Exchange Commission v. Hickey, 203 F.3d at 1131. But see SEC v. Cherif, 933 F. 2d 403 (7th Cir. 1991) (holding the District Court did not have the power to issue a pre-judgment asset freeze against an independent non-party whose assets were controlled by the third party, not subject to the total domination and control of the defendant in the SEC action).

Securities and Exchange Commission v. Private Equity Management Group, Inc., 2009 WL 1941400 (C.D. Cal. 2009)
In a civil enforcement action, the Receiver was appointed as receiver over one of two named corporate defendants and over the assets that “belong to, are being managed by, or in the possession of or control of” the named receivership entity and its “subsidiaries and affiliates.” The Receiver made a motion for instructions and clarification of the receivership order, asking the District Court to determine that six additional entities constituted receivership entities within the scope of the receivership order on an alter ego basis. The District Court characterized the first issue before the Court as whether the six additional entities were “separate and distinct from the entity defendants or are they affiliates of the entity defendants?”

The District Court cited the “flexible” approach for determining when a corporate entity may be disregarded in the context of an SEC action that was described by the District Court for the District of Nevada in SEC v. Elmas Trading Corp., 620 F. Supp. 231 (D. Nev. 1985), and held that based on the factors cited in that decision, the six entities should be deemed affiliates of the named receivership entities and subject to the receivership order. Factors cited by the District Court included the common control of the six entities by the owners and members of the named receivership entities, including the power of the owners and members to direct the transfer of funds by those entities.

Relying on the San Vicente case, the District Court in Private Equity Management concluded that the fact the six entities are affiliates of the named receivership entities alone did not allow the District Court to exercise jurisdiction over their assets but instead the Court was required to determine whether its exercise of jurisdiction would meet due process standards. As in San Vicente, the Court concluded that due process was satisfied under the International Shoe standards and found that the six entities had adequate notice of the action in that the entity defendants had “substantial control” over the other six non-party entities and their close relationship with the named defendants meant that notice to the named parties served to provide notice of the litigation to the other six non-party entities.

Tips and Issues for Consideration

The Receiver in San Vicente mailed notice of the Court’s order to show cause to the limited partners of the partnership which the Receiver was seeking to include in the receivership as well as subsequent notices which became an important factor in the Court’s opinion, providing substantial support for the fact that the limited partners had notice of the receivership and a fair opportunity to object to the Receiver’s handling of the receivership and to protect their rights.
The Receiver in Private Equity Management sought instructions and clarification of his duties regarding the entities not formally named in the receivership order early in the case to define the scope of his duties and to obtain an explicit order rather than relying on the language of the receivership order covering “subsidiaries and affiliates.”
The Hickey and Homeland Communications decisions highlight the implications of bringing additional entities into a receivership, which may include not just their assets (which may be uncertain early in the case) but also their debts (the nature and extent of which also may be unknown early in the case).

Cases Addressing Jurisdiction Issues in Receiver’s Recovery of Assets
Two recent decisions of the federal Court of Appeals confirm that the federal district court in which the receivership case is pending has subject matter jurisdiction over actions filed by the Receiver against third parties arising out of the receivership and for recovery of receivership property. These cases confirm that “ancillary jurisdiction” exists in the receivership court based on the District Court’s subject matter jurisdiction in the federal agency’s enforcement action which is properly before the District Court under federal question jurisdiction.

Crawford v. Silette, 608 F. 3d 275 (5th Cir. 2010)
This action arose out of a civil enforcement action by the Commodities Futures Trading Commission (“CFTC”) against an individual (Hudgins) who allegedly operated a Ponzi scheme. Defendant Silette was the perpetrator’s girlfriend who received a gift of $368,000 from Hudgins, from which she used $328,000 to pay off the mortgage on her condominium in Florida. Plaintiff Crawford was the Receiver appointed by the District Court for the Eastern District of Texas in the CFTC action. The Receiver sued Silette in the District Court in the Eastern District of Texas, petitioning the Court for an order imposing an equitable lien on the condominium and allowing the Receiver to take control of Silette’s condominium to sell it and recover the funds transferred to her by Hudgins. The District Court granted relief to the Receiver, ordered Silette to transfer the condominium to the Receiver, and Silette appealed.

Silette argued that the District Court did not have subject matter jurisdiction over the Receiver’s petition and that the action was subject to the “local action doctrine.” In rejecting that contention, the Fifth Circuit stated, “This argument fails; federal law creates subject matter jurisdiction for federal receivers,” citing 28 U.S.C. § 754 and Haile v. Henderson National Bank, 657 F. 2d 816 (6th Cir. 1981). The Court stated that the petition was properly brought by the Receiver in the receivership court in Texas. The Court also rejected claims by Silette that the District Court could not impose an equitable lien on her homestead under Florida law, concluding that Florida law authorizes an equitable lien to be imposed on a homestead both based on fraud and unjust enrichment.

Robb Evans & Associates LLC v. Holibaugh, 609 F. 2d 359 (4th Cir. 2010) (petition for writ of certiorari pending)
The Receiver was appointed in a civil enforcement action brought by the Federal Trade Commission (“FTC”) in the District Court for the District of Maryland. The assets of the receivership estate included Infinity Resources Group, Inc. (“Infinity”), a company that made loans to friends and family members of the individual defendant in the FTC action, as well as small consumer loans. The Receiver filed suit in the receivership court in the District of Maryland against an individual based on an outstanding promissory note owed to Infinity and obtained judgment against the defendant. The defendant appealed, asserting that the District Court did not have subject matter jurisdiction over the lawsuit and that ancillary jurisdiction does not apply or has been limited by the enactment of the supplemental jurisdiction statute, 28 U.S.C. § 1367.

The Fourth Circuit rejected the defendant’s argument and affirmed the subject matter jurisdiction of the receivership court over the Receiver’s proceedings against third parties under the common law doctrine of ancillary jurisdiction. The majority opinion specifically drew a distinction between the application of § 1367 to claims asserted in a case and held that the statute “does not affect common law ancillary jurisdiction ‘over related proceedings that are technically separate from the initial case that involved federal subject matter jurisdiction,’ which remains governed by case law.” That case law includes such venerable decisions as Pope v. Louisville, N.A. & C. Ry. Co., 173 U.S. 573 (1899) and White v. Ewing, 159 U.S. 36 (1895). The majority in the Fourth Circuit concluded the District Court properly exercised subject matter jurisdiction over the action which was in furtherance of the Receiver’s duties to marshal the individual’s assets pursuant to the receivership order. A petition for rehearing or for rehearing en banc was denied. The appellant recently filed a petition for writ of certiorari in the United States Supreme Court.

Tips and Issues for Consideration

Timely filing certified copies of the complaint and receivership appointment orders under 28 U.S.C. § 754 may be important to create jurisdiction in the receivership court, although a number of cases recognize that there may be reasons why filings are delayed, including lack of notice of the existence of the receivership asset in the jurisdiction in question. Several decisions indicate that the issuance of a preliminary injunction providing for appointment of a permanent receiver re-starts the 10-day filing period under § 754 and also that the receivership court can issue a reappointment order to allow the Receiver to make a timely § 754 filing to bring assets within the receivership.
Actions filed outside the receivership court may require the Receiver to independently meet the federal subject matter jurisdiction requirements of a federal question or diversity or to proceed in the state court of general jurisdiction.

*Gary Owen Caris, Esq. is a partner and Lesley Anne Hawes is of counsel in the Los Angeles office of McKenna Long & Aldridge LLP, an internatinal law firm with 475 attorneys and public policy advisors in ten offices in the United States and Europe.