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SECURITIES AND EXCHANGE COMM. v. HEARTLAND GROUP

May 2, 2003

SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF, VS. HEARTLAND GROUP, INC., DEFENDANT


The opinion of the court was delivered by: Joan Humphrey Lefkow, United States District Judge

MEMORANDUM OPINION AND ORDER

Plaintiff the Securities and Exchange Commission ("SEC"), filed this action on March 21, 2001 seeking appointment of a receiver for the benefit of investors to marshal, conserve, protect, hold, sell or otherwise dispose of, all assets of defendant Heartland Group, Inc.'s High-Yield Municipal Bond Fund, Short Duration High-Yield Municipal Fund and Taxable Short Duration Municipal Fund (collectively the "Funds"). The court appointed Phillip L. Stem ("Receiver") as receiver over any such assets. Before the court is the Receiver's motion to compel the Bank of New York ("BNY") to release all funds it is maintaining or intends to maintain in a reserve created to pay the expenses, including attorney's fees and costs, of U.S. Trust Company of Texas, N.A. ("U.S. Trust"). For the reasons set forth below, the court denies the motion.

BACKGROUND

On August 1, 1998, a Master Trust Agreement was formed between Desert Hot Springs Public Financial Authority (the "Authority") and Rancho Healthcare Inc., with U.S. Trust serving as the trustee. Under the Master Trust Agreement, the Authority issued 1998 Series A Tax-Exempt Bonds in the amount of $13,900,000 and 1998 Series B Taxable Bonds in the amount of $8,430,000 (collectively "Desert Hot Springs Bonds"). The proceeds of these Bonds were used to build a hospital in San Bernadino, California (the "Facility"). The Receiver claims that Heartland's Taxable Short Duration Fund currently owns $250,000 of the Authority's Series B Taxable Bonds.

In June 2001, U.S. Trust sold substantially all of its corporate trust business to BNY, thereby causing U.S. Trust to become the former trustee and BNY to become the successor trustee under the Master Trust Agreement. At the time of the sale, the Desert Hot Spring Bonds were in default.

On November 26, 2001, the Receiver instituted an action, on behalf of the bondholders whose interests he represents, in this court before the Honorable John A. Nordberg (case number 01 C 9078) against U.S. Trust (at this point the former trustee) alleging breach of fiduciary duty, breach of contract and negligence arising from the default of the Desert Hot Springs Bonds. On August 12, 2002, that action was transferred by the Multi-District Litigation Panel to the United States District Court for the Central District of California for coordinated pretrial proceedings with several other bondholder actions pending against U.S. Trust and other defendants arising out of the default of the Authority's bonds. These coordinated bondholder actions are in the early stages of litigation and discovery has not yet commenced.

BNY sent a "Notice to Holders of the Desert Hot Spring Bonds" ("Notice") on October 4, 2002 which stated that as of that date BNY, as successor master trustee, held $251,813.39 in the Bond Fund established under the Master Trust Agreement. The Notice stated that the successor master trustee had established a "Bondholder Claim Reserve" to cover the ongoing and anticipated estimated expenses, including those of BNY, properly payable from the trust assets under the Master Trust Agreement. The Notice also stated that as successor master trustee BNY established a "U.S. Trust Reserve" to cover the expenses that U.S. Trust estimated it would incur as a result of ongoing bondholder litigation.*fn1 This U.S. Trust Reserve is the point of contention between the parties here.

On October 29, 2002, the Receiver brought the current motion to compel, arguing that under the terms of the Master Trust Agreement, the Master Trustee is entitled to reimburse only "itself' for certain costs and expenses incurred as Master Trustee and that no former trustee is entitled to reimbursement. Therefore, according to the Receiver, BNY is not permitted to reimburse U.S. Trust for costs and expenses incurred after it was removed as Master Trustee because no provision of the Master Trust Agreement allows the Master Trustee to withhold bondholder funds to pay a former trustee's costs and expenses. The Receiver asks this court to compel BNY to release all funds it is currently holding in the U.S. Trust Reserve and to deposit them into the bond fund for the benefit of all the bondholders.*fn2

DISCUSSION

In response to the Receiver's motion to compel, BNY argues (1) the court lacks jurisdiction to hear the motion; (2) the documentary evidence establishes that the former trustee is entitled to reasonable attorney's fees and expenses and priority payment; and (3) the Receiver has failed to establish grounds for injunctive relief U.S. Trust argues that (a) the Master Trust Agreement creates indemnification rights in favor of U.S. Trust; (b) grounds for injunctive relief have not been demonstrated; (c) the motion is premature; and (d) the Receiver's motion should be dismissed because U.S. Trust has not been afforded Due Process.

As always, the court will begin its analysis with the issue of jurisdiction. While BNY does not specifically state which jurisdiction (subject-matter or personal) this court lacks, its argument focuses on the issue of personal jurisdiction, both in rem jurisdiction over the property at issue and in personam jurisdiction over BNY itself. In any event, subject matter jurisdiction could not be seriously disputed, as the motion to compel would fall under this court's jurisdiction in the original action brought by the SEC against the Heartland Group for violations of the securities laws.

The issue of personal jurisdiction, however, is more complex. After a review of the cases discussed more fully below, this court could have personal jurisdiction in two scenarios: (1) if the court had in rem jurisdiction over the assets or (2) if the court had in personam jurisdiction over BNY. The Receiver focuses most of his argument on the first avenue of personal jurisdiction, claiming that this court has in rem jurisdiction over the assets in question based on this court's March 21, 2002 Order (Docket #5). According to the Receiver, this March 21 Order grants the court exclusive jurisdiction over any of the Funds' assets wherever they may be located. E.g., Wabash R. Co. v. Adelbert Coll, of the W. Reserve Univ., 208 U.S. 38, 53 (1908); Eller Indus., Inc. v. Indian Motorcycle -Mfg., Inc., 929 F. Supp. 369, 371-372 n. 2 (D. Colo. 1995). BNY counters this argument by noting that while the court may have had jurisdiction pursuant to the March 21 Order, such jurisdiction was "divested" because the Receiver did not abide by 28 U.S.C. § 754. Section 754 provides,

A receiver appointed in any civil action or proceeding involving property, real personal or mixed, situated in different districts shall, upon giving bond as required by the court, be vested with complete jurisdiction and control of all such property with the right to take possession thereof
He shall have capacity to sue in any district without ancillary appointment, and may be sued with respect thereto as provided in section 959 of this title.
Such receiver shall, within ten days after the entry of his order of appointment, file copies of the complaint and such order of appointment in the district court for each district in which property is located. The failure to file such copies in any district shall divest the receiver of jurisdiction and control over all such property in that district.
28 U.S.C. § 754. According to BNY, because no § 754 filing has been made in New York, where the trust assets are located, both the court and the Receiver lack in rem jurisdiction over any such assets.

In response, the Receiver first argues that no filing was required because § 754 does not apply when the Receiver is seeking relief from the court that appointed him. The Receiver cites two cases which he believes supports his view. See, e.g., Scholes v. African Enter., Inc., No. 90 C 3989, 1993 U.S. Dist. Lexis 4210, at *8 (N.D. Ill. April 2, 1993) ("Section 754 allows the receiver to `sue in any district without ancillary appointment' and then imposes limitations upon that extended power; it does not divest the Receiver of his power to proceed in a court that retains ancillary jurisdiction if the required filings are not executed in other districts."); Tcherepnin v. Franz, 439 F. Supp. 1340, 1344 (N.D. Ill. 1977) ("Furthermore, the required filing of a copy of the complaint and order of appointment in a district where property involved is situated is not applicable where, as here, the court of appointment already has jurisdiction over the claim involved."); but see, Gilchrist v. General Elec. Capital Corp., 262 F.3d 295, 302 (4th Cir. 2001) ("But [the district court's] jurisdiction over assets in other districts is dependent upon the receiver's filing a copy of the complaint and appointment in that district, a condition that the receiver fulfilled in this case."); SEC v. Vision Communications, Inc., 74 F.3d 287, 290 (D.C. Cir. 1996) ("By not complying with § 754, the receiver failed to establish control over the property. His failure precluded the district court from using § 754 as a stepping stone on its way to exercising in personam jurisdiction over Vista Vision."); American Freedom Train Fndtn. v. Spurney, 747 F.2d 1069, 1073 (1st Cir. 1984) ("Section 754 is ancillary to the main suit in which the receiver is appointed, and the purpose of the statute is to give the appointing court jurisdiction over property in the actual or constructive possession and control of the debtor, wherever such property may be located."); United States v. Arizona Fuels Corp., 739 F.2d 455, 460 (9th Cir. 1984) ("A receiver achieves jurisdiction and control of ...


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