Appeal from the United States District Court for the Western District of Pennsylvania (D.C. 97-cv-02257)
Before: Sloviter, Alito, Rendell Circuit Judges
The opinion of the court was delivered by: Rendell, Circuit Judge
Argued September 14, 1998
We are asked on this appeal to determine whether the District Court erred in releasing the funds of certain investors from a freeze order entered in the context of receivership proceedings instituted by the Securities and Exchange Commission. Appellants are several Pennsylvania school districts who invested funds with defendants. They contend that the District Court orders of May 11 and May 22, 1998 improperly released funds of other investors, denied appellants certain procedural rights in connection with the court proceedings attendant thereto, and also erred in its award of attorneys' fees to the equity receiver appointed in the case. Appellees not only counter these positions, but also challenge our jurisdiction to hear this appeal.
Appellants appeal from five orders entered by the District Court in the ongoing receivership proceedings instituted by the SEC against John Gardner Black ("Black"), Devon Capital Management, Inc. ("Devon"), and Financial Management Sciences, Inc. ("FMS") under the provisions of Section 20(b) of the Securities Act, 15 U.S.C. § 77t(b), Sections 21(d) and (e) of the Exchange Act, 15 U.S.C. § 78u(d), (e), and Section 209(d) of the Advisors Act, 15 U.S.C. § 80b-9(d). The five orders at issue include an April 7, 1998 order approving payment of attorneys' fees and expenses ("fee order"), an April 22, 1998 order adopting procedures for a hearing regarding the distribution of funds and an April 27, 1998 order modifying the April 22 order ("procedural orders"), and a May 11, 1998 order modifying a freeze order and a May 22, 1998 order modifying the May 11 order ("orders lifting the freeze").
For the reasons set forth below, we will affirm the procedural orders and the orders lifting the freeze.
In August 1997, during a routine investigation of Devon, the SEC discovered that Devon was carrying assets on its books at materially inflated values and had incurred massive trading losses totaling at least $50 million of the $345 million entrusted to it by its investment clients. The investigation also determined that Devon and Black *fn1 were concealing the losses from their clients, most of whom were school districts and governmental entities, and were continuing to accept funds from new investment clients without disclosing information regarding these losses. The SEC believed that Devon was seeking new clients so as to use their funds to fulfill obligations to existing clients under their investment advisory agreements. On September 26, 1997, the SEC filed an action in the United States District Court for the Western District of Pennsylvania against Black, Devon and FMS seeking to enjoin their illegal conduct and freeze their assets pending an investigation. The SEC alleged violations of Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a), Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R.§ 240.10b-5, promulgated thereunder against Black, Devon and FMS, and violations of Sections 206(1), (2) and (4) of the Investment Advisers Act of 1940, 15 U.S.C. SS 80b-6(1), 80b-6(2), 80b-6(4), and Rule 206(4)-2, 17 C.F.R. § 275.206(4)-2, promulgated thereunder against Black and Devon.
The District Court granted the SEC's motion for entry of a temporary restraining order whereby all assets "presently held by [defendants], under their control or over which they exercise actual or apparent investment or other authority, in whatever form such assets may presently exist and wherever located" were to be immediately frozen. The order was entered pursuant to Section 20(b) of the Securities Act, 15 U.S.C. § 77t(b), Sections 21(d) and (e) of the Exchange Act, 15 U.S.C. § 78u(d), (e), and Section 209(d) of the Advisors Act, 15 U.S.C. § 80b-9(d). Pursuant to this order, the customer accounts later categorized as A, B, C and D were frozen.
The court appointed Richard Thornburgh as the equity receiver ("Trustee"), and he employed Price Waterhouse, LLP to provide accounting and auditing services for the ensuing investigation. The Trustee identified four general categories of investment relationships between defendants and their investor clients. Category A clients entered into an investment advisory and management relationship with Devon whereby Devon had authority to direct the purchase and sale of securities investments held in the name of the client at the client's custodian bank. Category A includes clients who entered into investment management arrangements whereby the client bore the risk and benefit of performance of investments, clients with investment advisor arrangements with a guaranteed minimum rate of return whereby Devon bore the risk of investments, and clients with investment advisor arrangements with afixed rate of return whereby Devon bore the risk, and would reap the benefit, of investments. Category B includes those clients who entered into Repurchase Agreements ("Repos") and Non-Pooled Collateralized Investment Agreements ("CIAs") with defendants. Under Repos, Devon used client funds to buy securities, chosen by Devon, at a set price, and later would re-sell the securities at a set, higher price, providing an assured return. The securities were held in the interim in the client's name by a custodian bank which held a promise of Devon's repurchase obligation. The Repos required Devon to provide additional securities on behalf of the client if the securities' value fell below the set purchase price. Under non-pooled CIAs, Devon used clients' funds to invest in FMS "units" that were credited to the client's account. FMS promised a fixed rate of return to the client and granted the client a security interest in securities held by a custodian bank. Category C clients entered into agreements with Devon similar to B non-pooled CIAs, except that the securities serving as collateral for the FMS "units" were pooled in one account in the name of FMS at Mid-State Bank ("MSB"). Category D clients entered into investment management arrangements with Devon similar to the A clients, except that MSB served as the custodian of the D accounts. As with the A and B accounts, the D accounts were held in the clients' names. Pursuant to the foregoing agreements, the defendants managed the accounts of A, B and D clients, while the actual funds or securities of those clients remained either in their own names or with a custodian bank named by them, other than MSB. The funds and/or securities invested by clients of the C accounts were maintained in a pooled account in the name of FMS in its principal depository bank, MSB. The present shortfall in assets is primarily in the pooled account at MSB. As of September 30, 1997, although approximately $156,000,000 had been invested in pooled CIAs on behalf of the C clients, the value of the collateral underlying the pooled account was only approximately $86,000,000.
After assessing the different types of contractual arrangements that existed, the Trustee investigated the extent to which defendants used the pooled account holding the C clients' funds in order to sell securities to, purchase securities from, or grant collateral to, clients that were in the other categories of investment relationships with defendants. The Trustee believes that through the use of the pooled account, defendants may have used certain funds deposited by the C clients for the benefit of the A, B and D clients. The Trustee has attempted to identify and quantify examples of such transactions, using the term "cash taints" to refer to cash transfers from the pooled account to accounts of non-pooled clients without the receipt of consideration, and the term "securities taints" to refer to transfers of securities between pooled and non-pooled clients at non-market prices, benefitting the non-pooled clients at the expense of the pooled account. *fn2 In addition, evidence suggests that defendants used the pooled account to fund lawsuits, settle complaints, and pay FMS's operational expenses. The Trustee has not alleged any complicity or actual involvement of the holders of the A, B and D accounts in this allegedly fraudulent scheme under investigation by the SEC.
Following the initial freeze order, the Trustee and the SEC jointly filed a motion on October 27, 1997 to modify the freeze to allow a distribution to the A, B and D clients of 50% of the market value of the funds held in their name, and to allow a distribution to the C clients of 50% of the market value of their pro rata share of the assets held in the pooled account. The District Court entered an order to allow this proposed distribution. On March 10, 1998, the Trustee filed a motion for further modification of the freeze to permit a second distribution to the investment advisory clients. This motion proposed a distribution to the A, B and D clients of 90% of the assets held in their name, reduced by the estimated total dollar value of whatever "taints" were identified by the Trustee, and a distribution to the C clients of 90% of their pro rata share of the remaining market value of the assets in the pooled account. The Trustee requested that funds sufficient to cover the alleged tainted transactions remain subject to the freeze pending afinal resolution by the court concerning the entitlement to such funds. On March 18, 1998, the District Court entered an order setting an April 29, 1998 hearing date on the motion for the proposed second interim distribution. The court also allowed all investment clients to file any objections to the motion with the Trustee and the SEC. On April 22, 1998 the District Court entered a hearing management order setting forth the procedures to be followed during the April 29, 1998 hearing. In response to an emergency motionfiled by several of appellants, the court revised these procedures in an April 27 order. The District Court conducted a hearing on the motion for a second distribution on April 29 and April 30. In a Memorandum Opinion entered May 11, 1998, the District Court directed the Trustee to release the funds of all A, B and D clients from the freeze, and to distribute to the C clients 90% of each client's pro rata share of the remaining pooled assets. The order ...