Opinion ID: 3010602
Heading Depth: 1
Heading Rank: 4

Heading: propriety of the orders lifting the freeze

Text: In its May 11, 1998 and May 22, 1998 orders, the District Court lifted the freeze as to the A, B and D clients' funds. We hold that the District Court did not err in so doing. We reject appellants' characterization of the District Court's May 11, 1998 and May 22, 1998 orders lifting the freeze. Contrary to appellants' urgings, the court did not, pursuant to these orders, adjudicate claims and decide that the A, B and D clients are entitled to receive all of their funds or that the C clients should bear all of the $70,000,000 in losses. The court's orders did not distribute property, decide claims, or bar consideration of alleged taints. The order is clear that it did not decide claims, stating, this Order does not constitute a final adjudication of any claims by or between investment advisory clients. Rather, the District Court only determined that, based upon the factual record regarding the relationship of the A, B, C and D accounts to the defendants, the court lacked power over the A, B and D funds. The Trustee's investigation revealed that the injunction initially imposed pursuant to the freeze order was overly broad, and the District Court therefore modified the terms of the restraint. The District Court did this after it was convinced that the Defendants did not have `control' over funds maintained by Category A, B, or D clients. . . 15 so as to permit this Court to freeze the funds pursuant to 15 U.S.C. SS 78u(d) and (e). Implicit in the District Court's ruling was a finding that the Trustee's investigation had not adduced any proof either that the Category A, B or D funds were, or could be deemed, assets of the defendants, or that the investors themselves were implicated as wrongdoers and thus within the purview of 15 U.S.C. SS 78u(d) and (e).6 The SEC argues in its brief that the District Court had the authority to impose and to continue the asset freeze over the A, B and D accounts pursuant to Federal Rule of Civil Procedure 66 since the freeze was part of an ongoing receivership proceeding governed by the jurisdictional provisions of the federal securities laws. 15 U.S.C. SS 77v(a), 78aa, 80b-14. However, the case law cited by the SEC actually supports the District Court's determination that the freeze as to these funds was improper because in no case referenced by the SEC has it been granted a freeze ex parte of assets where those assets were anything other than property, or deemed property, of a defendant or of a culpable third party. See, e.g., SEC v. Cherif, 933 F.2d 403, 413-14 (7th Cir. 1991) (Nothing in the statute or case law suggests that 15 U.S.C. S 78u(d) or (e) authorizes a court to freeze the assets of a non-party, one against whom no wrongdoing is alleged.). Although the SEC and appellants cite many cases that they claim stand for the proposition that the SEC can freeze assets of a nonculpable third party, all of these cases are distinguishable from the case at hand. For example, in Deckert v. Independence Shares Corp., 311 U.S. 282, 284 (1940), where assets frozen were in the hands of a third party, the assets were clearly en route to the defendant and actually belonged to the defendant. In In re San Vicente Med. Partners Ltd., 962 F.2d 1402, (9th Cir. 1992), the frozen third-party assets at issue were owned by a limited partnership, whose general partner was a subsidiary of the defendant and thus, the defendant _________________________________________________________________ 6. Although not stated, we assume it was crucial to the court's view that the C accounts should remain subject to the freeze, that these accounts were not merely accounts in the names of individual investors, but, rather, were commingled funds in a pooled account in the name of FMS at Mid-State Bank. They, clearly, were funds over which the defendants had control. 16 controlled the third party's property as a matter of law. See also SEC v. Colello, 139 F.3d 674 (9th Cir. 1998) (allowing the court to name an innocent third party as a nominal defendant in order to recover proceeds of fraud); SEC v. Wencke, 783 F.2d 829, 834 (9th Cir. 1986) (discussing claim of a nonparty based only on the decreased value of the nonparty's assets, not on the freezing of assets or a disgorgement order affecting the nonparty); SEC v. Universal Financial, 760 F.2d 1034 (9th Cir. 1985) (inapplicable because it relates to a stay of legal proceedings, as opposed to a freeze of assets, applicable to a nonparty); Tcherepnin v. Franz, 485 F.2d 1251, 1257 (7th Cir. 1973) (stating that the court could assume jurisdiction over land held by nonparties where the nonparties were not good faith purchasers for value and were instruments in defendants' fraudulent scheme); SEC v. Comcoa, Ltd., 887 F. Supp. 1521 (S.D. Fla.) (holding that funds in a trust account held by defendants' lawyer on behalf of defendants were subject to freeze), aff'd sub nom. Levine v. Comcoa, Ltd., 70 F.3d 1191 (11th Cir. 1995); SEC v. Antar, 831 F. Supp. 380 (D.N.J. 1993) (stating that the court could assume jurisdiction over illegal profits where such profits were held by the wife and children of defendant). The SEC also cites as support for its argument SEC v. Institutional Treasury Management, Inc., No. 91-6715 RG, 1991 SEC LEXIS 2791 (C.D. Cal. Dec. 12, 1991). This case does not support the SEC's argument, however, since in this case too the court released the funds of the innocent investors. See SEC v. Institutional Treasury Management, Inc., No. 916715 RG, 1991 SEC LEXIS 2915 (C.D. Cal. Dec. 23, 1991). In addition, appellants do not argue complicity by the A, B and D investors, but contend that, under a common enterprise theory, the A, B and D accounts are liable for funds expended from the C accounts and used to the benefit of the investors having funds in A, B and D accounts. While we recognize the potential for recovery for the C investors from A, B and D investors who allegedly benefitted, this situation does not contain the level of complicity or involvement in wrongdoing on behalf of the A, B and D investors that is necessary to support the unilateral freeze of assets under the statute as occurred here. See, e.g., Cherif, 933 F.2d at 413-14 (district court 17 not authorized to freeze the assets of a non-party against whom no wrongdoing is alleged under 15 U.S.C. S 78u(d) or (e)). Although the Trustee's report discussed the existence of evidence showing commingling and transfers between the pooled and non-pooled accounts, there is no evidence that this was done by anyone other than defendants. Transfers or invasion of the pooled account for the benefit of others accomplished by FMS or Devon do not implicate the A, B and D investors in such a way as to make their assets the proper subject of a freeze based on defendants' wrongdoing. Further, appellants' characterization of the District Court as having refused to decide the issue of who should bear the loss of the alleged taints is not entirely accurate. The District Court did not refuse to decide the taints issue, but, rather, this issue is, as it should be, reserved for another day. Nothing in the relinquishment of the freeze over the A, B and D accounts prevents the Trustee from pursuing the issue of taints.7 Further, as has become clear from our review of the record of proceedings before the District Court and the Bankruptcy Court, the Trustee's pursuit of these causes of action to recover the taints from the A, B and D account holders has not been cast aside, but remains of key concern. These causes of action may well constitute important assets, the pursuit of which is at _________________________________________________________________ 7. The Trustee, too, objected to lifting the freeze as to any of the allegedly tainted funds in the A, B and D accounts. However, assuming that the Trustee's argument in this regard would be similar to that of the SEC, which filed a brief and argued before us, we see no merit in this position. It appears that the Trustee's position is based primarily upon the desire to pursue causes of action against these allegedly tainted funds, but, as we have indicated, we view that as an issue separate and apart from the issue as to whether the court had power over these assets initially, sufficient to justify the issuance of the ex parte order. The fact that the Trustee wants to have these assets under his control in order to claim recovery from them does not constitute legal support for their continued freeze pursuant to the initial ex parte order. We also note that no party has argued that lifting the freeze would result in the dissipation or removal of assets from the jurisdiction of the court. To the contrary, the investors whose funds are in these accounts are school districts presumably with ample funding, who are available to receive service of process. 18 the very heart of these proceedings.8 In fact, we note and applaud the Bankruptcy Judge's concern for this issue as reflected in his refusal to dismiss the bankruptcy case, stating: We . . . find it advisable to permit these bankruptcy cases to proceed to determine whether they provide a better process for resolving issues left unresolved by the district court. We read in these words an appropriate concern that assets are properly marshaled and distributions properly ordered in connection with a reorganization or liquidation of these debtors. Appellants also object to the method of distribution of any funds released from the freeze. Appellants argue that the released funds should be divided pro rata among all categories of investors, as opposed to among only the A, B and D investors, and, more importantly, that the losses in the pooled account should be borne by all of defendants' clients, as opposed to just the C clients. Intervenors argue that the District Court's orders were proper, with the A, B and D investors getting back 100% of their principal, and the losses in the pooled account being divided pro rata among the C investors only. Since the District Court orders regarding the distribution of the released funds state clearly that they do not constitute a final adjudication of any claims by or between investment advisory clients, and leave for another day the pursuit of claims against various holders of assets, which would in essence result in a redistribution of assets, the orders we have been asked to review do not constitute final rulings on asset distribution, and this issue, therefore, is not properly before us on this appeal. In summary, the District Court's orders lifting the freeze as to the A, B and D accounts were based upon a sound legal footing.9 Further, in issuing these orders, it did not _________________________________________________________________ 8. We express no opinion as to which forum is appropriate for this pursuit but assume that the best interests of all creditors and the Trustee's fulfillment of his fiduciary and statutory duties will guide the proceedings. 9. The fact that the court, although stating that it did not propose to address the freeze at that time, nonetheless sua sponte dissolved the 19 determine claims, foreclose pursuit of taints, or in any way resolve disputes or final distributions among the parties.