STEVE MARTHA HARSCH v. STATE OF ILLINOIS OFFICE OF BANKS AND REAL ESTATE (2011)

ORDER

This matter comes before the Court on the Complaint of STEVEN and MARTHA HARSCH, et al., and against the STATE OF ILLINOIS through the OFFICE OF BANKS AND REAL ESTATE. A trial on this matter was held on August 2-4, 2010, before Commissioner Andrea M. Buford.

FACTS

The Claimants herein and at all times relevant, held investment and or retirement accounts with Intrust. Intrust is an Illinois Corporation certified under the Illinois Corporate Fiduciary Act, 205 ILCS 620/1-1 et seq., (“Act”) by the Illinois Office of Banks and Real Estate (“OBRE”) to act as trustee for various types of Individual Retirement Accounts. (“IRAs”). Intercounty Title (“Intercounty”) was a company that offered title insurance to owners of real estate. Jack Hargrove (“Hargrove”) was the Chairman of Intrust's Board of Directors and the owner of Intrust through Intrust's parent company, Madison Avenue Investments. Laurence Capriotti (“Capriotti”) was a Director of Intrust. The principal registered officers and directors of Intrust were also the principal registered officers and directors of Intercounty.

The Illinois Corporate Fiduciary Act was enacted to protect the public interest and general welfare of the people of the State of Illinois. The Act entrusts OBRE with the responsibility to supervise corporate fiduciaries. The Act specifically provides for OBRE's supervision, regular examination and correction of any unsafe or imprudent practices of trust companies.

Specifically, the Act provides for an examination no less frequently than every 18 months. On each examination, inquiry shall be made as to the condition and resources of the corporate fiduciary generally, the mode of conducting and managing its affairs, the action of its directors and trustees, the investments of the funds, the safety and prudence of its management, the security afforded to those by whom its engagements are held, and whether the requirements of its charter and laws have been complied with in the administration of its affairs. 205 ILCS 620/5-2.

Whenever it appears from an examination that a corporate fiduciary has committed any violation of any law, has made or published a false statement of condition or is conducting its business in an unsafe, unsound or unauthorized manner, OBRE shall direct the discontinuance of such practices and that they strictly conform to the requirements of the law. 205 ILCS 620/5-3.

If a corporate fiduciary refuses or neglects to make a required statement of condition or any report required under this Act, or to comply with an order as above stated, or if it appears that it is unsafe or inexpedient for the corporate fiduciary to conduct business, OBRE shall enter an appropriate order which may include the appointment of a receiver, the taking of possession of the corporate fiduciary, or the removal of a director, officer, employee or agent of the corporate fiduciary. 205 ILCS 620/5-3. The Act does not provide for insurance of account holder's or corporate funds.

On December 4, 1990, Intrust entered into an escrow agreement with Intercounty Title. (“Escrow Agreement”). Pursuant to the Escrow Agreement, Intrust deposited the cash portions of customer accounts with Intercounty. Intercounty was obligated to pay Intrust a minimum rate of interest on the money deposited by Intrust. The Escrow Agreement obligated Intercounty to deposit the trust funds into an escrow account at the LaSalle National Bank of Chicago. (“Escrow Account”). Under the terms of the Escrow Agreement, Intrust retained no direct control over the Escrow Account. Intrust depended on Intercounty, as escrow agent, to follow Intrust's directions with respect to the operation of the Escrow Account. The Escrow Agreement gave Intrust no power to account for, withdraw, or safeguard the funds and they were not a signatory on the Escrow Account.

In December 1990, after entering into the Escrow Agreement, Intrust deposited $16,582,098.78 with Intercounty. In subsequent years, Intrust continued to deposit funds with Intercounty pursuant to the Escrow Agreement. At times the balance in the escrow account exceeded $100 million. By January 2000, the balance of funds should have been more than $68,000,000.

From the inception of the Escrow Account in December of 1990 until January 2000, Intercounty did not provide Intrust with copies of LaSalle Bank statements for the escrow funds. Instead, Intercounty provided Intrust with monthly spreadsheets prepared by Intercounty or others under the control of Hargrove or Capriotti purporting to show the balances of deposits. The monthly spreadsheets falsely reported balances. Capriotti, Hargrove and others misappropriated Intrust funds sometime after December 1990. To date more than $68,090,000 in deposits and reported accrued interest have been misappropriated from funds that were deposited by Intrust with Intercounty.

On or about July 14, 2005, Capriotti plead guilty to multiple counts for his role in the misappropriation and received fourteen (14) years in jail. Capriotti admitted that he, Hargrove and others conspired to defraud Intrust, its account holders and others of the money in the escrow account; that they engaged in acts to conceal the scheme from Intrust's president, auditors, OBRE and others; that he obstructed and made false statements and promises to OBRE and Intrust's president in connection with OBRE's efforts to protect the Intrust holder funds; admitted to causing OBRE examiners to receive what purported to be an account statement that stated as of May 31, 1997, the Intrust Escrow account contained $54,894,943; and in connection with the OBRE 1998 examination provided what purported to be an escrow statement showing a balance of $54,840,446 as of August 31, 1998. In or around May 2006, Hargrove was sentenced to fourteen (14) years in jail for his conduct involving the misappropriation of the subject funds.

In connection with OBRE's duties they conducted a general examination on Intrust at least once per calendar year. Each examination report from 1991-1998 contains a sworn statement detailing the assets and liabilities of Intrust in which Intrust reported they were not aware of any misappropriation of corporate or fiduciary funds. In 1991, in the comment section of its report, OBRE reported the company's cumulative trust accounts were inexplicably out of balance and short by over $400,000.00. An OBRE examiner stated the shortage had existed for several years and had not been rectified and that pursuant to the Order of December 28, 1990, amounts not reconciled by December 31, 1991, were required to be charged off by Intrust. The accounts were eventually reconciled. In the September 1991 independent audit the auditor found the depositor funds in Intercounty could not be examined or verified, which led to a qualified opinion on the company's soundness. The February 25, 1994, OBRE examination report reported Intrust's “commingling of trust assets with that of an affiliate which violates common law trust principals. One of the fundamental duties of a fiduciary is to keep trust accounts separate. Management should separate its accounts.” Intrust responded to the report and disagreed with the comments.

Between 1994 and 1995, Intrust deposited nearly 10 million in additional trust funds with Intercounty and the commingled deposits through Intercounty to LaSalle National Bank amounted to approximately $40 million. In 1995 the OBRE examination report reported the comingling of funds between Intrust and Intercounty. The report commented that Intrust does not receive statements directly from the bank but relies on spreadsheets supplied by Intercounty. The report further stated Intrust made two large capital loans to Intercounty without a valid contractual agreement until after the fact, without first obtaining credit information on the debtor and without effectuating an inspection or appraisal of the collateral.

In the January 1996 OBRE report, the examiner pointed out that Intrust was comingling trust assets with affiliate's assets. Between 1995 and 1996, Intrust deposited nearly $7,000,000 in additional funds with Intercounty. On August 1, 1996, Intrust's independent auditors issued a qualified audit report. At that time approximately $57,000,000 was at risk. On June 23, 1997, Intrust's independent auditor issued another qualified audit report. At that time approximately $94,000,000 was at risk. In April 1997, OBRE's report stated Intrust's business practices constituted a patent weakness in account administration.¹

On June 25, 1998, Intrust's independent auditors issued another qualified report and warned of the possibility that $54,000,000 in trust funds could be lost as a result of Intrust's deposits with an affiliate. On August 31, 1998, the OBRE report stated the findings of the independent auditor was qualified because no independent verification of trust cash was permitted by the company; the escrow arrangement with Intercounty represented a major conflict of interest, in that fiduciary funds are benefitting an affiliate company; and the situation needs to be monitored and steps taken to ensure funds are under Intrust's control.²

In April 1999, pursuant to the directions of Capriotti and Hargrove, Intrust wire transferred $9,200,000 in additional deposits to the escrow account. OBRE was not informed of this transfer. Intercounty withdrew the $9,200,000 almost immediately after the transfer, leaving a balance of $45,949.24.

Some time prior to August 3,1999, OBRE requested verification from Intrust that Intrust officials had been added to the LaSalle Account, that no withdrawals could be made without Intrust authority, required account documentation directly from LaSalle bank and a copy of the LaSalle and Intercounty repurchase agreement. On August 10, 1999, OBRE informed Intrust it needed to take immediate corrective action regarding the escrow account with Intercounty. On August 24, 1999, Capri otti assured OBRE that the escrow account issues would be addressed at the Intrust board meeting that day. On September 1, 1999, OBRE requested that Intercounty transfer escrow funds to a separate established account at Cole Taylor bank immediately as had been previously requested on August 31, 1999. Intrust had a Certificate of Good Standing stating Intrust was qualified to conduct business as a trust. After September 15, 1999, inquiries on Intrust would be directed to the OBRE website. On September 15, 1999, OBRE issued a Corrective Action Order, posted on the OBRE website, outlining the escrow account issues and requiring Intrust to terminate the escrow account arrangement with Intercounty and take control of the trust assets and properly account for trust assets. On September 30, 1999, OBRE was notified by Intrust's president that the escrow arrangement with Intercounty had still not been rectified. On October 7, 1999, OBRE requested Intrust comply with the Sept. 15 corrective order no later than October 15, 1999. On October 12, 1999, Intrust reported to OBRE that it would take care of the issue in a couple of days. On October 15 and October 19, OBRE contacted Intrust's president to inquire about the escrow account. On October 20, an OBRE examiner was sent to Intrust to investigate the escrow situation. On November 9, 1999, OBRE examiners attended an Intrust Board of Directors meeting and were told the escrow account would be taken care of no later than November 19, 1999. On November 17, OBRE met with Capriotti on another matter at which time Capriotti blamed Intrust's president for the problems related to the corrective order and stated he would address the issues on November 18, 1999.

On January 1, 2000, Intrust provided bank and broker statements to OBRE showing account totals matching the Intrust account totals. By January 19, 2000, OBRE was informed that Intrust had not yet complied with the September 1999 Corrective Action Order. On February 7, 2000, OBRE subpoenaed account verification for Intrust from LaSalle Bank³ and Harris Bank. On February 10, 2000, Intrust provided signature cards for accounts with only Intrust employees. On March 2, 2000, OBRE issued an order stating that Intrust's practices and condition pose a threat to the Corporation's ability to operate in a safe, sound and authorized manner. The order required Intrust to fully comply with the Corrective Action Order within 10 days, increase capital to an amount not less than the escrow assets, recover the funds in escrow from Intercounty, file a bond claim and remove any Intercounty affiliated person from all Intrust account authority. In April 2000, OBRE took possession of Intrust and placed the company in receivership. At that time, over $68,090,000 in funds and reported interest had been lost.

On or after April 14, 2000, Claimants received individual notice of the receivership. Sometime thereafter Claimants' accounts at Intrust were frozen. Approximately $4 million dollars has been recovered on behalf of the Claimants and receiver litigation is still ongoing. The receiver has declined to pursue any action against the State of Illinois and Claimants were given leave by the Chancery Court to separately file this action.

LEGAL ANALYSIS

The issue at the heart of this matter is whether the Office of Banks and Real Estate owed a duty to the Claimants and whether they breached that duty under the Illinois Corporate Fiduciary Act, 205 ILCS 620 et al. Pursuant to the Act, OBRE is charged with examining trust operations to inquire “as to the condition and resources of the corporate fiduciary generally, its mode of conducting and managing its affairs, the action of its directors or trustees, the investments of its funds, the safety and prudence of its management, the security afforded to those by whom its engagements are held, and whether the requirements of its charter and of the laws have been complied with in the administration of its affairs.” The statute further authorizes the Commissioner to take action should it be determined that a violation exists.

The testimony and exhibits produced indicate OBRE complied with its statutory mandate to examine the trust operation. The Respondent argues they do not owe a duty to the Claimants; that the decisions of the Commissioner fall within his discretionary duties; that the Corporate Fiduciary Act does not create a private cause of action; that Claimants failed to exhaust remedies against their investment advisors; and that no decision can be made by the Court until the receivership is closed. The Claimants argue that the Corporate Fiduciary Act mandated a clear and non-discretionary duty on OBRE to stop unsafe or unsound practices; that the Court in ruling on the Respondent's Motion to Dismiss, rejected Respondent's arguments that OBRE could not be liable for the performance or nonperformance of discretionary acts; that the Claimants have no private right of action against OBRE; or that they did not have a claim for negligent representation. The Court in its Order stated, “the allegations of the Claimants, taken as true for the purposes of the Motion to Dismiss, raise an issue of fact as to whether the alleged negligent acts were the result of the use of discretion undertaken in good faith.” The Court goes on to state, “if the allegations of the Consolidated Complaint are taken as true, then Claimants have stated a cause of action that would stand against a private person or corporation.” However, the burden of proof when ruling on a motion to dismiss is not the same as when ruling after a trial on the merits. Therefore we find this Court can consider the argument raised that OBRE could not be held liable for the performance or nonperformance of discretionary acts.

Generally speaking, the courts have refused to impose liability on similar agencies for their alleged negligent conduct in performing their statutory duties. Harmsen v. Smith, 586 F.2d 156 (9th Cir. 1978). In Harmsen, the court held that the directors of a bank could not maintain actions for indemnity against the United States for the alleged negligence of the comptroller in conducting bank examinations. Notwithstanding the holding of the court on the issue of statutory duty, in Tcherepnin v. Franz, 393 F.Supp. 1197 (N.D. Ill. 1975), opinion supplemented 424 F.Supp 778, affirmed 570 F.2d 187, cert.denied 99 SCt. 214, 439 U.S.76, the court held, “Illinois decisions have consistently held that public officials vested with discretion and empowered to exercise their judgment are immune from liability to third persons provided that the acts complained of are discretionary in nature, done with the scope of the official's authority and not resulting from malicious or corrupt motives.” Although Tcherepnin dealt with the liability of the Director, we find the discussion on ministerial versus discretionary instructive and hold the acts complained of in the instant case are discretionary in nature. The language of the Corporate Fiduciary Act vests the Respondent with certain discretionary acts throughout the statute. Similarly, on the national level, a number of courts have refused to hold a regulatory agency liable for the performance of its discretionary duties in the examination of banking institutions. FDIC v. Irwin, 916 F.2d 1051 (5th Cir. 1990), In Re Franklin National Bank Securities Litigation, 478 F. Supp. 210 (E.D.N.Y. 1979).

Since the acts complained of are discretionary in nature, in order to answer the question of whether the Respondent violated its statutory duties we must examine whether the Respondent was willful or malicious in acting or failing to act. This requires an examination of the facts and a determination on what the Respondent knew and when. The Respondent was aware of the following:

1. On Dec. 4, 1990, Intrust entered into an escrow agreement with Intercounty Title. The agreement obligated Intercounty to deposit funds into an escrow account at LaSalle National Bank.

2. Intrust retained no direct control over the escrow account. Intrust was not a signatory on the escrow account.

3. The principal registered officers and directors of Intrust were also the principal registered officers and directors of Intercounty.

4. In the 1991 examination report, OBRE commented that the trust accounts were out of balance and short by over $400,000.00. The accounts were reconciled.

5. In the 1994 examination report, OBRE commented that commingling trust assets with that of an affiliate violates common trust principals and that management should separate its accounts. Intrust disagreed with the comments.

6. In the 1995 examination report, OBRE commented that Intrust's escrow account is in the name of Intercounty, that Intrust does not receive statements directly from the bank but relies on Intercounty spreadsheets, which results in comingling of funds, and that Intrust made two large capital loans to Intercounty without a valid contract and without obtaining credit information on the debtor and without an inspection or appraisal of any collateral.

7. In the 1996 examination report, OBRE commented that Intrust has been commingling trust assets with affiliate's assets.

8. In the 1997 examination report, OBRE commented Intrust's regular business practices constituted a patent weakness in account administration and violated the company's basic fiduciary duty to safely control the depositors' funds.

9. In the 1998 examination report, OBRE commented that an independent audit of Intrust's financial statements was qualified in that no independent verification of trust cash was permitted by the company; that the escrow agreement with Intercounty represented a major conflict of interest; and that the situation needs to be monitored and steps taken to insure funds are under Intrust's control; and that is was difficult to get information on the arrangement and an actual bank statement was not received, only a photocopy.

10. Some time prior to Aug. 3, 1999, OBRE requested verification from Intrust that it had been added to the trust account, that no withdrawals could be made without Intrust authority, account documentation directly from the bank and the Intercounty repurchase agreement.

11. On Aug. 10, 1999, by letter, OBRE informed Intrust it needed to take immediate corrective action regarding the escrow account.

12. On Aug. 24, 1999, OBRE received verbal assurances the issues would be addressed at the Intrust board meeting on that day.

13. On Sept. 15, 1999, OBRE issued a Corrective Action Order, requiring Intrust to terminate the escrow agreement with Intercounty, to take control of the trust assets and properly account for the trust assets.

14. On Oct. 7, 1999, by letter, OBRE again requested that Intrust comply with the Corrective Order.

15. On Oct. 12, 1999, Intrust informed OBRE the matter would be taken care of in a couple of days.

16. On Oct. 15 and 19, 1999, OBRE contacted Intrust about the escrow account.

17. On Oct. 20, 1999, OBRE sent an examiner to Intrust to investigate the escrow situation.

18. On Nov. 9, 1999, OBRE examiners attended an Intrust Board meeting and were told the matter would be taken care of by Nov. 19, 1999.

19. In Jan. 2000, Intrust provided bank statements showing totals matching Intrust totals for the trust account.

20. On Jan. 19, 2000, OBRE became aware that Intrust had not complied with the Order.

21. On Feb. 7, 2000, OBRE subpoenaed account verification from the bank. This was a practice that had never been done before.

22. On Feb. 10, 2000, Intrust gave OBRE signature cards for accounts with only Intrust employees.

23. On Mar. 1, 2000, OBRE issued an Order stating that Intrust's practices and condition pose a threat to their ability to safely operate; that Intrust fully comply with the Corrective Order in 10 days, increase capital to cover the escrow assets, recover the money in escrow from Intercounty, file a bond claim, cease placing money in the escrow, and remove any Intercounty affiliated person from all Intrust account authority.

24. In April 2000, OBRE took possession of Intrust and appointed a receiver.

An examination is not an audit. The purpose of the examination is to gather information to rate the institution under the Uniform Inter-Agency Trust Rating system. The examiner relies upon information provided by the institution. And in this case, examiners were misled. Mr. Capriotti admitted he conspired to defraud Intrust and concealed and provided false statements in furtherance of his acts, including false statements showing a valid trust account balance as of May 31, 1997, and May 31, 1998. Although comments were made concerning the trust account, each year Intrust received a passing component rating. OBRE did not have a formal procedure for what to do when a potential issue arises during an audit. It is left to the discretion of the examiner as to when an issue may be unsafe and “taken up” to the next level.

OBRE did not violate its statutory duty up to September 1999 when the Corrective Action Order was entered. We next examine the time period between September 1999 and when a receiver was appointed in April 2000, some 7 months later. After the CAO was entered and up until the time a receiver was appointed, OBRE was going back and forth with Intrust attempting to obtain compliance with the Order. During that period of time and in January of 2000, OBRE was provided with bank statements showing a valid account balance. It was not until February 2000, when OBRE, with an action outside of its regular practices, issued a subpoena upon the bank. OBRE was unsure of the process and not certain that the federal bank would even honor the subpoena. However, the records were obtained and in March 2000, OBRE issued an Order of the Commissioner requiring Intrust, among other items, to fully comply with the CAO, increase capital, recover funds in escrow from Intercounty, and remove any Intercounty affiliated person from the account. In April 2000, a receiver was appointed. We find OBRE did not violate its statutory duty between September 1999 and April 2000.

Here, OBRE under its statutory grant of authority examined the corporate fiduciary. OBRE identified issues with the trust account and partially because of the criminal and fraudulent misrepresentations made, OBRE, in good faith, took the actions identified. The decision as to what actions to take was discretionary. There is no proof of any willful or malicious conduct on the part of OBRE. We follow the line of cases that have refused to hold regulatory agencies liable for allegedly negligently performing discretionary functions. We find that the Claimants have failed to establish that the Respondent had a duty to the account holders. Therefore, OBRE did not have a duty to the account holders and further, even if a duty could be assumed, the discretion accorded would lead to the conclusion that OBRE did not breach its duty.

IT IS HEREBY ORDERED that based on the foregoing, the claims of the Claimants are hereby denied.

FOOTNOTES

1.  According to Mr. O Brien, OBRE Examiner in Charge (“EIC”) for the 1997 examination, the comingling issue was cured but there was an issue with control over the new escrow account in that Intercounty had signature authority.

2.  According to Mr. Mennel, EIC for the 1998 examination, a LaSalle Bank statement showed $54 million in the escrow account.

3.  This was not part of the regular examination process and had never been done before.

SPRAGUE, C.J.