Court Opinion

ID: 2994906
Source: CourtListenerOpinion
Date Created: 2015-09-24 19:17:19.584971+00
Date Added: 2024-06-11T18:01:23.377514
License: Public Domain

In the
United States Court of Appeals
For the Seventh Circuit

No. 00-2028

Robert F. Rifkin, Raymond G.
Scachitti, and Patrick J. Houlihan,

Plaintiffs-Appellants,

Derivatively on behalf of County of
Cook, Nominal Plaintiff, on behalf of
itself and all other municipal and
governmental entities similarly
situated,

Plaintiff-Appellee,

v.

Bear Stearns & Co., Inc., Public
Sector Group, Inc., Seaway
National Bank of Chicago, and
Ernst & Young, L.L.P.,

Defendants-Appellees.

Appeal from the United States District Court
for the Northern District of Illinois, Eastern
Division.
No. 99 C 3549--Charles R. Norgle, Sr., Judge.

Argued January 25, 2001--Decided April 19,
2001

  Before Coffey, Ripple, and Diane P. Wood,
Circuit Judges.

  Diane P. Wood, Circuit Judge. In 1992,
Bear Stearns & Co., with the help of the
other defendants in this case,
orchestrated a bond refinancing plan for
Cook County. According to the plaintiffs,
the way the defendants handled the
transaction cheated Cook County and the
United States Treasury out of almost
$250,000. The plaintiffs, citizens of
Cook County who were not purchasers of
the bonds and had no direct involvement
in the refinancing transactions, brought
this suit alleging violations of the
federal Investment Advisers Act of 1940,
15 U.S.C. sec. 80b-1 et seq. ("the
Advisers Act"), the Illinois Recovery of
Fraudulently Obtained Public Funds Act,
725 ILCS 5/20-101 et seq. ("Article XX"),
and Illinois common law. The district
court dismissed the case on the ground
that the plaintiffs lacked standing to
bring their claims in federal court. We
agree, with respect to the Advisers Act
claim, and we conclude further that the
court did not have even supplemental
jurisdiction over the state law claims,
as there were no proper federal claims to
which the state claims could be appended.
We therefore affirm the judgment of the
district court.

I

  In 1992, interest rates were dropping.
Cook County wanted to take advantage of
the new lower rates by retiring old
municipal bonds it had issued at higher
rates and replacing them with new bonds
issued at the lower rates. It could not
accomplish this goal directly, for the
simple reason that the old bonds had not
yet matured. Bear Stearns helped the
county develop a plan to get around this
problem. First, using Bear Stearns as
broker, the county issued new bonds,
known as "advance refunding bonds," at
the new, lower rates. The proceeds from
these bonds were used to purchase U.S.
Treasury Bonds, which were placed in an
escrow account and used to pay off the
old bonds as they matured. The interest
on advance refunding bonds is generally
tax exempt, which makes them attractive
to investors. On the other hand, in order
to maintain the bonds’ tax exempt status,
the local government issuing the bonds is
not permitted to earn a profit from the
escrowed Treasury bonds. If the escrowed
bonds generate revenues over the amount
needed to pay off the old bonds, the
excess must be turned over to the
Treasury; if that does not happen, the
IRS may declare the interest on the
advance refunding bonds taxable.

  This feature of the advance refunding
bond mechanism gives brokers such as Bear
Stearns an opening to engage in a
practice known as "yield burning."
Because the yield of a Treasury security
is inversely related to its price, a
broker who wanted to reduce the yield
(and thus the potential that excess
yields would need to be returned to the
Treasury) would mark up the price of the
bonds. Although at first blush one might
think that the local government would
object to an inflated price, its
incentive to do so might be reduced
because of the effect of the higher price
on the interest generated by the escrowed
Treasury bonds: less interest (as long as
there is enough to pay the holders of old
bonds) means less that the local
government has to return to the federal
government.

  That is what the plaintiffs in this case
allege happened to Cook County and its
taxpayers. Bear Stearns, they claim,
engaged in yield burning when it served
as the lead underwriter for the issuance
of the 1992 Cook County advance refunding
bonds, earning almost $250,000 in
improper profits in the process.
According to the plaintiffs, the yield
burning harmed the county in two ways:
first, if Bear Stearns had charged only
the market rate for the Treasury bonds
and all of the accounting on the escrow
account had been done properly, the
county would have been entitled to keep
approximately $32,000 of the money Bear
Stearns appropriated before the escrow
accounts began generating profits.
Second, the yield burning meant that the
county was not paying the appropriate
amount to the Treasury, which jeopardized
the advance refunding bonds’ tax exempt
status. (The adverse consequences for
federal revenues are, it seems, the
principal evil of yield burning; it is
unclear to what extent the practice
inflicted other harm on the county or the
plaintiffs, and given our resolution of
the case on standing grounds we make no
comment on that point.)
  The plaintiffs brought this suit in May
1999, alleging claims under the Advisers
Act, Article XX, and various common law
theories. In addition to Bear Stearns,
the plaintiffs sued Public Sector Group,
Inc. (PSG) and Seaway National Bank of
Chicago, both of which served as
financial advisors to the county with
respect to the transaction, and Ernst &
Young, which prepared a report verifying
the mathematical accuracy of Bear
Stearns’ calculations with respect to the
escrow accounts. The plaintiffs relied on
general federal question jurisdiction, 28
U.S.C. sec. 1331, for their Advisers Act
claim, and supplemental jurisdiction, 28
U.S.C. sec. 1367, for their state-law
claims. They did not, and do not, allege
that the parties are diverse or that any
other grounds would support subject
matter jurisdiction over the state-law
claims.

  The district court found that the
plaintiffs, whose only connection to the
transactions they challenge was as Cook
County taxpayers, lacked standing to
bring their claims in federal court under
both the core standing requirements of
Article III of the U.S. Constitution and
the prudential standing doctrines. In
this appeal, the plaintiffs argue that
Illinois’s Article XX, which allows
taxpayers to sue on behalf of local
governments in certain circumstances, is
sufficient to confer Article III standing
on them, and that where a state statute
specifically creates taxpayer standing,
prudential standing considerations are
irrelevant. We review the district
court’s decision to dismiss this case for
lack of standing de novo. Perry v.
Sheahan, 222 F.3d 309, 313 (7th Cir.
2000).

II

  This court has recently held, in a case
very similar to this one, that standing
to bring a federal claim in federal court
is exclusively a question of federal law
and that a state statute permitting
taxpayer standing cannot override federal
law. See Illinois ex rel. Ryan v. Brown,
227 F.3d 1042, 1045 (7th Cir. 2000). In
Ryan, the plaintiffs sought to bring RICO
claims on behalf of the State of
Illinois, alleging, as do the plaintiffs
here, that Article XX, which (as the
formal name suggests) allows citizen
suits to recover sums fraudulently
obtained from government entities in some
situations, see 735 ILCS 5/20-101 to -
104, conferred standing on the plaintiffs
to sue on behalf of Illinois in federal
court. In response to that argument, we
stated unequivocally that "[t]he mere
fact that Illinois courts would recognize
the plaintiff’s standing to bring such an
action . . . does not mean that he has
standing to bring a federal action
arising from the same occurrence. The
plaintiff’s standing to assert a
federally-created right is not controlled
by state law." 227 F.3d at 1045. Instead,
the appropriate question was "whether, as
a matter of federal law, a taxpayer
derivative suit or citizen suit [on this
kind of claim] is permissible." Id. This
holding governs our analysis in the
present case. It means that the
plaintiffs have standing to pursue their
Advisers Act claim in the federal courts
only if they can satisfy the requirements
of Article III without reference to
Illinois’s statute.

  As the Supreme Court has emphasized, the
requirement that a plaintiff have
suffered an "injury in fact," defined as
"an invasion of a legally protected
interest which is . . . concrete and
particularized," is an "irreducible
constitutional minimum of standing."
Lujan v. Defenders of Wildlife, 504 U.S.
555, 560 (1992). It is axiomatic that
being a citizen or taxpayer of an injured
governmental body, without more, is not a
sufficient injury in fact to create
standing for the taxpayer to seek redress
of the government’s injury. See Lujan,
504 U.S. at 573-74; Schlesinger v.
Reservists Committee to Stop the War, 418
U.S. 208, 220 (1974) ("[S]tanding to sue
may not be predicated upon an interest of
the kind alleged here which is held in
common by all members of the public,
because of the necessarily abstract
nature of the injury all citizens
share."). As we stated in Ryan, "general
taxpayer actions are not permitted" in
federal court. 227 F.3d at 1046. Because
the plaintiffs here assert only a
generalized injury shared by all
taxpayers of Cook County, they have not
met the irreducible constitutional
minimum requirements for standing in
federal court.

  In an effort to avoid that result, the
plaintiffs reiterate an argument that the
parties in Ryan asserted unsuccessfully,
both in the principal case and in their
arguments for rehearing. They urge that
their case is no different from the well
recognized device of shareholder
derivative suits, which are an example of
an individual bringing a claim on behalf
of a larger entity. There, as here, one
entity’s claim (that of the corporation)
is assigned to the volunteer plaintiff
essentially by operation of law, after
the efforts by the plaintiff to have the
corporation assert its own rights have
failed or would have been futile, as long
as the plaintiff would be an adequate
representative for the corporation. But
there is an important difference between
shareholder suits and the kind of
taxpayer suit these plaintiffs wish to
bring that they have not confronted. As
Kamen v. Kemper Financial Servs., Inc.,
500 U.S. 90 (1991), pointed out, state
law governs the rules for allocating
power within a corporation, and it is
thus logical to hold that state law
governs the circumstances under which a
shareholder may be empowered to speak for
the corporation in a derivative suit. Id.
at 99. When the criteria for a derivative
suit are met, the shareholder may bring
whatever substantive claim the
corporation may have had.

  The current taxpayer suit is quite
different. Not even the plaintiffs allege
that there is a state law that
establishes a procedure under which a
taxpayer or citizen may displace an
Illinois county for all substantive
purposes. If there were, then we agree
our case would look much more like Kamen,
and we would need to decide if the
plaintiffs had properly qualified
themselves to speak for the county and
whether the county had Article III
standing to sue. We would also confront
the difficult question whether, in light
of the Supreme Court’s repeated
admonitions that taxpayers suits are not
permitted in federal court, a suit
brought under this hypothetical state
statute would be exempt from the standing
doctrines that normally bar such suits.
But Illinois has not enacted such a
statute. Instead, there is a specific
statute, Article XX, that makes it
unlawful fraudulently to obtain monies
from a state governmental unit and that
empowers citizens under very specific
circumstances to sue to recover that
money. Article XX therefore creates both
a claim and a remedy, including a limited
delegation of authority to citizen-
plaintiffs. Nothing in Article XX
purports to allow county citizens or
taxpayers to speak for the government on
claims outside its scope, and we do not
have the authority so to expand it.

  The plaintiffs’ remaining attempts to
distinguish their case from Ryan are
easily disposed of. First, the plaintiffs
suggest that the Ryan opinion dealt only
with state common law taxpayer standing,
not with a state statute specifically
authorizing taxpayer suits. But this
represents too narrow a view of the
holding of Ryan. The point there was that
state law in general, whether Article XX
or common law, was irrelevant to the
question whether suit could be brought
under a particular federal statute, there
RICO. See 227 F.3d at 1044-45. The same
analysis applies here. Whether taxpayers
can sue to vindicate Cook County’s rights
under the Advisers Act is a question that
must be answered with reference to
federal law, both at the level of Article
III and prudential standing, and if need
be at the statutory level. This argument
is therefore without merit.

  The plaintiffs’ final argument is that
the Supreme Court’s recent decision in
Vermont Agency of Natural Resources v.
United States ex rel. Stevens, 120 S. Ct.
1858 (2000), requires a finding of
standing here (and, they admit, by parity
of reasoning in Ryan). In Vermont Agency,
the Court held that a federal qui tam
statute in effect creates an assignment
of the federal government’s claim to the
qui tam relator, so that the appropriate
analysis of standing in a qui tam case
focuses on whether there has been a
cognizable injury to the government, not
whether there has been a cognizable
injury to the relator. 120 S. Ct. at
1863. The plaintiffs argue that the
holding in Vermont Agency is equally
applicable to state-law qui tam cases. In
a sense, they take the position that our
analysis of Advisers Act standing is
omitting a key step in the process. By
operation of Article XX, they claim, Cook
County’s claims against Bear Stearns and
the other defendants were assigned to
them. As the legal holders of claims that
satisfy all relevant standing criteria
for a federal action, they are no longer
mere taxpayers, but are the same as Cook
County itself. The appropriate question
is therefore whether Cook County has
suffered a cognizable injury, not whether
the qui tam relators have.

  This argument, however, simply recasts
the basic point we have already rejected.
If we were to accept it, states could
confer taxpayer standing for any federal
claim they wished, simply by allowing
taxpayers to claim they were suing on
behalf of a governmental entity. Nothing
in the Advisers Act indicates that this
type of assignment is permissible, unlike
the situation in Vermont Agency where the
federal statute that provided the basis
of the claim also effected "a partial
assignment of the Government’s damages
claim." 120 S. Ct. at 1863. Were the
plaintiffs asserting an independent
ground for our subject matter
jurisdiction over the Article XX claim,
such as diversity jurisdiction, the
holding of Vermont Agency might be closer
on point. In such a case, however, we
would have to confront other difficult
questions in this case, such as whether
Article XX creates a valid assignment of
Cook County’s state law claim against the
defendants to these relators, whether the
extent of the assignment is sufficient to
give the relators a "concrete private
interest in the outcome of the suit,"
Vermont Agency, 120 S. Ct. at 1862, and
whether Article XX’s procedural
requirements were met in this case. As
the defendants point out, none of these
questions is easily answered.

  We need not reach them in the case as
actually presented, because the
plaintiffs have not asserted that we have
jurisdiction over their Article XX claim
independent of our jurisdiction over
their Advisers Act claim. Rather, the
only ground for federal jurisdiction over
the Article XX claim that plaintiffs have
alleged is supplemental jurisdiction
under 28 U.S.C. sec. 1367. The district
court is empowered to take supplemental
jurisdiction over state claims only if
the court first has "original
jurisdiction" of the claim to which the
state claims are attached. See 28 U.S.C.
sec. 1367(a). Since we have concluded
that the lack of standing over the
Advisers Act claim was jurisdictional in
nature, the district court also had no
subject matter jurisdiction over the
Article XX claim.

  The plaintiffs seem to want us to treat
all three of their claims, in the
aggregate, as a "qui tam case." But, as
we have already noted, the Advisers Act
is not a qui tam statute, and nothing in
that statute suggests a congressional
intention to allow taxpayer derivative
actions under it. The plaintiffs must
establish the district court’s
jurisdiction over each of their claims
independently; they are not permitted to
use one count of their complaint to
establish federal subject matter
jurisdiction and a separate count to
establish standing. Compare Warth v.
Seldin, 422 U.S. 490, 500 (1975)
(standing analysis "often turns on the
nature and source of the claim asserted,"
because "[t]he actual or threatened
injury required by Article III may exist
solely by virtue of statutes creating
legal rights, the invasion of which
creates standing"). Vermont Agency’s
discussion of standing in qui tam cases
is simply irrelevant to the plaintiffs’
standing to bring their Advisers Act
claim.

III

  The plaintiffs lack standing to bring
their claim under the Investment Advisers
Act in federal court. Because they lack
standing to bring their federal claim,
the district court had no authority to
exercise supplemental jurisdiction over
their remaining state law claims. In
light of these conclusions, we have no
occasion to discuss the question whether
claims under the Advisers Act are subject
to the same one year/ three year statute
of limitations that applies to similar
securities claims. See Lampf, Pleva,
Lipkind, Prupis & Petigrow v. Gilbertson,
501 U.S. 350 (1991); Kahn v. Kohlberg,
Kravis, Roberts & Co., 970 F.2d 1030 (2d
Cir. 1992). Nevertheless, we thank the
parties for their supplemental briefs on
that issue. The judgment of the district
court is Affirmed.