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TCHEREPNIN v. FRANZ

April 14, 1975

ALEXANDER TCHEREPNIN ET AL., PLAINTIFFS,
v.
ROBERT FRANZ ET AL., DEFENDANTS.



The opinion of the court was delivered by: Robson, Chief Judge.

    MEMORANDUM AND ORDER

This matter comes before the court on the motion of cross-plaintiff City Savings Association (City Savings), by its receiver Samuel Berke, and pursuant to Rule 56 of the Federal Rules of Civil Procedure for entry of summary judgment on Counts I, II and III of its Amended First Cross-Complaint against cross-defendant First National Bank & Trust Company of Alton, Illinois, executor of the estate of Joseph E. Knight (Estate of Knight). In addition, the Estate of Knight has moved to dismiss Counts I, II and III of the Amended First Cross-Complaint. Cross-defendant Justin Hulman has joined in the motion to dismiss and has adopted the Estate of Knight's memorandum in support thereof. For the reasons set forth below, the motions to dismiss shall be denied and the receiver's motion for summary judgment shall be granted as to Counts I and II and denied as to Count III.

This complex and protracted litigation involves the events surrounding the collapse of City Savings Association, a savings and loan association chartered by the State of Illinois and presently under the control of federal receivers. The history of City Savings and its mentor, C. Oran Mensik, is a chronicle of political intrigue and corruption perhaps unmatched in Illinois history. It is replete with examples of official misconduct and chicanery and permeated with a blatant disregard by both state and City Savings officials for the rights of the unfortunate depositors. The result of these defalcations was a massive fraud which milked the depositors of nearly $23,000,000.

To fully comprehend the allegations made in the Amended First Cross-Complaint, the history of City Savings and of this litigation must first be reviewed in some detail.

Events Prior to the Commencement of This Litigation

City Savings Association was founded in 1908 in Chicago, Illinois. It issued to its depositors withdrawable capital shares, as authorized by the Illinois Savings and Loan Act, Ill.Rev.Stat. 1963, ch. 32, §§ 701-944. City Savings was located in and serviced an area known as the Chicago-Ashland business district, a focal point for various Chicago ethnic groups. The Failure of the City Savings Association, a report to the Illinois General Assembly, Illinois Legislative Investigating Commission, January, 1972 (hereinafter referred to as Legislative Report), p. 1.

In 1942, C. Oran Mensik, the principal manipulator of this fraud, first became associated with City Savings. Mensik's emergence as president and director of City Savings, six months later, marked the beginning of an astounding period of economic growth. When Mensik joined City Savings there were 348 shareholders and $147,000 in assets. By 1952, the reported assets of City Savings had reached $12,000,000 and in the next five years this figure climbed to over $35,000,000. Mensik remained in control of City Savings until at least 1964. Legislative Report, p. 1.

On July 18, 1956, the Auditor of Public Accounts for the State of Illinois, the public official then charged with the supervision of state-chartered savings and loan associations, ordered state examiners to conduct an examination of the books and records of City Savings. Subsequent examinations were made in October 1956 and February 1957. The last examination report was sent to the management of City Savings on April 16, 1957, and was accompanied by a letter from the Auditor outlining the State's criticisms and recommendations. On April 23, these examinations were released to the press. The resulting publicity caused a run on City Savings. On April 25, 1957, the Auditor declared an "emergency," took custody of City Savings and closed its doors to the public. Ill.Rev.Stat. 1955, ch. 32, § 848; Legislative Report, pp. 3-8.

The examination findings upon which the Auditor relied revealed: that the capital of City Savings was severely impaired; that certain favored companies staffed and operated by Mensik's associates and relatives had received a disproportionate amount of mortgage loans; that properties securing mortgage loans were greatly overappraised; and that Mensik was involved in two other guarantee associations which were both in financial straits. Legislative Report, p. 7.

In response, Mensik filed suit in the Circuit Court of Cook County charging that the Auditor and five of his associates were engaged in a conspiracy to "steal" Mensik's associations from him. The matter was referred to Nathan M. Cohen as Master in Chancery. After an extensive hearing, the Master concluded that the responsibility for the emergency was chargeable to the Auditor because of his untimely release of the confidential report and that the state seizure was therefore illegal. On December 6, 1957, Judge Cornelius Harrington adopted the Master's findings and ordered that control of City Savings be returned to Mensik. This decision was ultimately affirmed by the Supreme Court of Illinois in 1960. Mensik v. Smith, 18 Ill.2d 572, 166 N.E.2d 265 (1960).

Judge Harrington, however, also found that some of the criticisms registered by the Auditor were valid and retained supervisory jurisdiction over City Savings to oversee the implementation of certain suggested remedial measures. One of these suggestions was the institution of a system of limited and restricted withdrawals pursuant to Section 773(b) of the Illinois Savings and Loan Act, Ill.Rev.Stat. 1963, ch. 32, § 773(b). Legislative Report, pp. 8-11.

On December 19, 1957, City Savings was reopened to the public. On February 3, 1959, Judge Harrington determined that the conditions which the court directed to be remedied had been in fact corrected and terminated all judicial supervision of City Savings. Legislative Report, p. 11.

The rapid growth experienced by City Savings prior to its 1957 closing declined sharply due both to the damaging publicity it had received and to its decision to operate under the provisions of Section 773(b). Legislative Report, p. 14.

On July 9, 1959, the Illinois General Assembly enacted Section 773(h) of the Illinois Savings and Loan Act. Ill.Rev.Stat. 1959, ch. 32, § 773(h.). It provided:

    (h) An association while operating under this
  Section may accept additional withdrawable capital
  from its present shareholders as well as accept new
  withdrawable capital accounts and such withdrawable
  capital accounts shall not be subject to the
  provisions of subsection (b) of this section but
  shall be subject to withdrawal at will so long as the
  association is operating under the provisions of
  subsection (b) of this section.*fn1

Mensik seized the unique advantages offered by this new law and embarked on an extensive advertising campaign, offering expensive prizes such as television sets and radios to new depositors. He also blazoned the maxim "Under State Government Supervision" on his letterheads and circulars. Legislative Report, p. 14.

In January 1964, the State Department of Financial Institutions, to whom supervisory authority over state-chartered savings and loan associations had been transferred, began an examination of the affairs of City Savings. The examination included an audit by Peat, Marwick, Mitchell & Co., independent public accountants, whose report dated June 15, 1964, showed a capital impairment of approximately $14,000,000. Tcherepnin v. Franz, 316 F. Supp. 714 (N.D.Ill. 1970). On June 26, 1964, the State of Illinois took custody of City Savings and on June 30, 1964, City Savings was closed to the public. Legislative Report, pp. 14-17.

On July 28, 1964, a meeting of the depositors of City Savings was held at which a plan of voluntary liquidation, agreed upon between Mensik and the State of Illinois, was put forward and approved by the depositors. Pursuant to the plan, three voluntary liquidators were appointed, one nominated by Mensik and the other two by the State of Illinois. Legislative Report, pp. 17-18.

The Federal Litigation

On July 24, 1964, four days prior to the depositors' meeting called to solicit approval of the plan of voluntary liquidation, the plaintiffs' complaint was filed by Alexander Tcherepnin and certain other holders of withdrawable capital shares of City Savings. Their complaint named Joseph E. Knight, then Director of the Department of Financial Institutions of the State of Illinois; Justin Hulman, then Supervisor of the Savings and Loan Division of the Department; certain officers and directors of City Savings; and Louis Kwasman, Harry Hartman and Dennis Kirby, the voluntary liquidators of City Savings, as parties defendant. Defendants Hartman and Kirby were savings and loan examiners and employees of the Department of Financial Institutions; Kwasman was a business associate and nominee of Mensik.

No wrongdoing was alleged by, and no relief was sought against, the named state officials or the State of Illinois. Nonetheless, on November 20, 1964, the Attorney General of the State of Illinois moved to strike and dismiss the complaint.

On January 17, 1966, Judge Campbell, before whom the matter was then pending,*fn2 denied all motions to dismiss plaintiffs' complaint and held that plaintiffs owned "securities" as defined by federal law, and certified his ruling for an interlocutory appeal. Tcherepnin v. Franz, 277 F. Supp. 472 (N.D.Ill. 1966).

On January 20, 1967, the United States Court of Appeals for the Seventh Circuit reversed Judge Campbell's order and, with one Judge dissenting, held that the plaintiffs were not in fact holders of "securities." Tcherepnin v. Knight, 371 F.2d 374 (7th Cir. 1967).

On December 18, 1967, the United States Supreme Court reversed the order of the court of appeals and held that plaintiffs' withdrawable capital shares were "securities" within the meaning of the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. Tcherepnin v. Knight, 389 U.S. 332, 88 S.Ct. 548, 19 L.Ed.2d 564 (1967). The matter was remanded to this court for further proceedings.

On February 9, 1966, the plaintiffs first moved for the appointment of a receiver to replace the state-supervised voluntary liquidators. Judge Campbell denied this motion but indicated that he would reconsider his decision after appellate review of his order sustaining plaintiffs' complaint. Tcherepnin v. Franz, 277 F. Supp. 472 (N.D.Ill. 1966).

On May 29, 1968, upon remand from the Supreme Court, plaintiffs renewed their motion for the appointment of a receiver. From August 19, 1968, to August 23, 1968, a full hearing on the motion was held.

  On September 7, 1968, Judge Campbell entered an order
appointing Leonard B. Ettelson and William J. Friedman receivers
of City Savings.*fn3 In this order Judge Campbell found that the
state-supervised plan of voluntary liquidation was:

     . . tainted with fraud. . . . No reasonable
  person could have concluded, and I specifically find
  that Justin Hulman did not believe on June 15, 1964,
  that the liquidation of City Savings
  Association . . . could ever result in anything but
  an enormous loss to the depositors. Nevertheless, the
  State, while in custody of City Savings Association,
  allowed C. Oran Mensik . . . to call a meeting of the
  shareholders [fraudulently] soliciting proxies. . . .
  Commissioner Hulman was aware of these
  misrepresentations before, during and after the fact
  and at no time did he prevent or correct these lies
  although he had the power and duty to do so. . . .
    I find and conclude that the representations made
  to the shareholders of City Savings Association were
  false, misleading and deceptive. . . . I therefore
  hold the voluntary liquidation is void because it was
  tainted with fraud from its inception.
  Order of September 7, 1968. This order was subsequently appealed and affirmed. Tcherepnin v. Kirby, 416 F.2d 594 (7th Cir. 1968).

On October 10, 1968, Judge Campbell entered an order tentatively delineating two classes of depositors — the plaintiffs consisting of post-July 9, 1959 depositors and the intervening defendants consisting of pre-July 9, 1959 depositors. On March 10, 1970, Judge Campbell held that the plaintiffs were entitled to a preference in the distribution of the assets of City Savings. This order was affirmed on appeal. Tcherepnin v. Franz, 461 F.2d 544 (7th Cir. 1972).

Thereafter, in November, 1974, the plaintiffs, intervening defendants and the receiver entered into a settlement agreement whereby the plaintiffs were dismissed from the case and any further recovery of assets would run to the benefit of the intervening defendants. The plaintiffs had recovered approximately 100 per cent of their investment in City Savings.

On August 6, 1970, Judge Campbell entered an order imposing a constructive trust on certain property located in the Chicagoland area for the benefit of City Savings and its depositors. Tcherepnin v. Franz, 316 F. Supp. 714 (1970). That order was also affirmed on appeal. Tcherepnin v. Franz, 485 F.2d 1251 (7th Cir. 1973).

On January 15, 1969, the receivers filed their First Cross-Complaint, naming Joseph E. Knight, Justin Hulman and Dennis Kirby as cross-defendants. On September 23, 1969, the receivers amended the cross-complaint to name Chris Stolfa, former Supervisors of Savings and Loan Associations of the State of Illinois, Louis Kwasman, Harry Hartman, William DeWoskin, Richard Ray and Steven J. Kadlicek, voluntary liquidators of City Savings, as additional cross-defendants. Cross-defendants Hartman and Kadlicek were also employees of the Department of Financial Institutions for the State of Illinois.

The cross-complaint was again amended to add the State of Illinois and Fidelity and Deposit Company of Maryland as additional cross-defendants. Fidelity and Deposit Company was the surety for the individual cross-defendants.

The gravamen of the Amended First Cross-Complaint is that the named officers and employees of the State of Illinois and the other voluntary liquidators breached their statutory duties to City Savings, thereby rendering themselves, the State of Illinois and their surety liable for damages to the depositors of City Savings.

On April 6, 1972, the State of Illinois moved to dismiss the Amended First Cross-Complaint and for summary judgment. The receivers filed a cross-motion for summary judgment. In a memorandum entered March 12, 1973, this court, with myself presiding, denied the State's motions and granted the receiver's cross-motion for summary judgment against the State of Illinois. In that memorandum, it was specifically found that, "The willful failure of the State through its officials, agents and employees to adequately supervise City Savings . . . was . . . willful and wanton negligence" and that the State was liable to the depositors of City Savings for the damages they incurred as a result of the collapse of that institution. Memorandum, Findings of Fact, Conclusions of Law and Decree entered March 12, 1973, p. 28.

Subsequently, the State and the receivers entered into settlement negotiations. On September 10, 1973, the Governor signed into law a bill passed by the 78th General Assembly appropriating $12,467,500 for the reimbursement of the depositors of City Savings.

On October 9, 1973, this court entered an agreed order approving a settlement between City Savings and the State of Illinois and ordering that the State be dismissed with prejudice as a cross-defendant.

On June 25, 1973, the Estate of Knight filed a motion to dismiss Counts I, II and III of the Amended First Cross-Complaint.

On November 5, 1973, the receiver filed a motion for summary judgment against cross-defendants Justin Hulman, Chris Stolfa, Louis Kwasman, Harry Hartman, Dennis Kirby, William DeWoskin, Richard Ray, Steven J. Kadlicek and the Estate of Knight, and on February 25, 1974, the receiver filed a motion for summary judgment against cross-defendant Fidelity and Deposit Company of Maryland. Although these motions were initially consolidated for briefing, pursuant to the request of the receiver, the motion for summary judgment against the Estate of Knight was placed on an accelerated briefing schedule and is the subject of this memorandum. The Estate of Knight is a named cross-defendant in the first three counts of the First Amended Cross-Complaint. These counts deal with events in chronological order and will be discussed individually.

Count I

Count I of the Amended First Cross-Complaint deals with events transpiring between 1959 and June 1964, when City Savings was closed by the State for the second time. Named as cross-defendants are the Estate of Knight, Chris J. Stolfa and Justin Hulman. Donald Swope, who was originally named as a cross-defendant, was dismissed pursuant to this court's order of October 9, 1973.

Joseph E. Knight was the Director of the Department of Financial Institutions for the State of Illinois from January 16, 1962, to April 1968. Prior to that appointment, he served as Secretary to the Illinois Commerce Commission under former Governor Henry Horner, Supervisor of Loan Companies under former Governor Adlai Stevenson and Assistant Director of the Department of Financial Institutions under former Governor Otto Kerner. Knight, pp. 4-5, 11; Legislative Report, p. 54.*fn4

Chris J. Stolfa was Supervisor of Savings and Loan Associations for the Department of Financial Institutions from 1959 (1960?) to November 1963. Stolfa had been a state employee since 1942. The bulk of his experience was in the area of state supervision of financial institutions. Stolfa, pp. 3-11; Legislative Report, p. 57.

Justin Hulman was first employed by the State of Illinois on January 15, 1964, as a technical advisor to Joseph Knight. Prior to that, in November and December 1963, Hulman acted as an unofficial advisor to Knight in connection with the examinations of various savings and loan associations which appeared to be in financial straits. On June 5, 1964, Hulman was appointed by Knight as Supervisor of Savings and Loan Associations for the Department of Financial Institutions. On August 1, 1965, his official designation was changed by statute to Commissioner of Savings and Loan Associations, a position he held until his resignation on October 1, 1969. Hulman, pp. 2-7; Legislative Report, pp. 55-56.

Donald Swope was acting Supervisor of Savings and Loan Associations from November 1963 to until June 6, 1964, when he was replaced by Hulman. Stolfa, p. 5; Knight, p. 9.

The Illinois Savings and Loan Act, Ill.Rev.Stat. 1963, ch. 32, §§ 701-944, in effect for the period 1959-63, imposed a comprehensive duty on the Director of the Department of Financial Institutions and the officers and employees of that department to supervise the affairs of all savings and loan associations within the state and to ensure that these businesses were operated "only by associations organized and conducted in accordance with the authority provided in this Act." Ill.Rev.Stat. 1963, ch. 32, § 702(b).

Section 842(a) of the Illinois Savings and Loan Act required the Director of the Department of Financial Institutions to at least once a year conduct an examination of every savings and loan association in the state:

    (a) The Director, at least once in each year,
  without previous notice, shall cause an examination
  to be made of the affairs of every association. Such
  examination shall be made by competent examiners
  appointed for that purpose, who are not officers or
  agents of, or in any manner interested in, any
  association which they examine, except that they may
  be holders of withdrawable capital.

Section 842(b) of the Act granted to the Director or his examiners access to the books and records of every savings and loan association and empowered them to question the management and employees of those associations regarding the conduct of its affairs:

    (b) The officers, agents, or directors of any such
  association shall cause the books of the association
  to be opened for inspection by the Director or his
  examiners and otherwise assist in such examination
  when requested; and for the purpose of examination,
  the examiner in charge thereof shall have power to
  administer oaths and to examine under oath any
  officers, ...

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