                             In the
 United States Court of Appeals
               For the Seventh Circuit
                         ____________

No. 02-3926

JAMES A. KNAUER as the Court Appointed Receiver for
HEARTLAND FINANCIAL SERVICES, INC. and JMS
INVESTMENT GROUP, LLC,
                                  Plaintiffs-Appellants,
                          v.

JONATHON ROBERTS FINANCIAL GROUP, INC.; ALLIANCE
CAPITAL MANAGEMENT CORP.; ANDOVER SECURITIES, INC.;
FSC SECURITIES CORPORATION and FFP SECURITES, INC.,
                                          Defendants-Appellees.
                         ____________
           Appeal from the United States District Court
    for the Southern District of Indiana, Indianapolis Division.
       No. IP01-1168-C-T/K—John Daniel Tinder, Judge.
                         ____________
    ARGUED MAY 29, 2003—DECIDED OCTOBER 22, 2003
                    ____________

 Before CUDAHY, EVANS and WILLIAMS, Circuit Judges.
  CUDAHY, Circuit Judge. Heartland Financial Services,
Inc., and JMS Investment Group, LLC, operated a Ponzi
scheme in the late 1990s that collected over $60 million
from hundreds of investors. In August 2000, in connection
with a Securities and Exchange Commission (SEC) action
against individuals and entities involved in the Ponzi
scheme, the district court appointed James A. Knauer as
receiver for Heartland and JMS. Subsequently, Knauer
began this lawsuit, alleging that the defendants were in
2                                               No. 02-3926

part responsible for losses resulting to Heartland and JMS.
The district court dismissed Knauer’s complaint, holding
that the doctrine of in pari delicto bars Heartland and JMS
from pursuing losses for which they themselves were
largely culpable. We affirm.


                             I.
  Because this case was dismissed under Fed. R. Civ. P.
12(b), we accept as true all well-pleaded factual allegations
and draw all reasonable inferences in the light most
favorable to the plaintiff. Dawson v. Gen. Motors Corp., 977
F.2d 369, 372 (7th Cir. 1992).
  Kenneth R. Payne founded Heartland Financial Services,
Inc., in January 1991 and served as its president. From
1994 to as late as August 2001, Heartland, together with
JMS Investment Group, LLC, which was founded in 1997,
and other affiliated companies, engaged in a massive fraud,
holding themselves out as brokerage, insurance and estate
planning firms and raising millions of dollars through
fraudulent sales of securities. Working with Payne in this
business were Daniel Danker, Heartland’s vice president
and office manager, Johann M. Smith, founder, manager
and attorney for JMS, and Constance Brooks-Kiefer, an
administrative assistant who worked for both JMS and
Heartland. Their operation was a classic Ponzi scheme.
Investors were promised extraordinarily high rates of
return, which in the beginning were realized, for the
purpose of encouraging greater reinvestment. By 1998,
Heartland had over 700 clients, who had invested $22.6
million with the company. Between December 1997 and
December 1999, JMS raised $18.5 million from over 250
investors. Altogether, the two companies and their affiliates
collected over $60 million. In reality, Heartland and its
affiliates did not invest most of the funds at all, but Payne
and his colleagues withdrew and spent the money for their
own personal benefit.
No. 02-3926                                                 3

  Payne and Danker were, at various relevant times, li-
censed as registered securities representatives of five
broker dealers, the defendants in this case—Jonathon
Roberts Financial Group, Inc., Alliance Capital Manage-
ment Corp., Andover Securities, Inc., FSC Securities
Corporation and FFP Securities, Inc. According to the
Complaint, these broker dealers, which were registered
under Section 15 of the Securities and Exchange Act and
with the National Association of Securities Dealers, had the
ability and the duty to supervise and control, directly and
indirectly, the activities of Payne and Danker, but failed to
exercise proper supervision or to maintain proper control.
The Complaint also alleges that Payne and Danker were
employees and agents of these companies, and that they
were able to perpetrate the Ponzi scheme in part because
they were able to hold themselves out as licensed registered
securities representatives of the broker dealers.
  On August 10, 2000, the SEC moved for, and the dis-
trict court granted, a temporary restraining order against
Payne and Danker. As part of the proceedings, the district
court removed Payne, Danker, Smith and Brooks-Kiefer
from control of Heartland and JMS and appointed James
A. Knauer as receiver for the two companies.1 According
to the court’s order, Knauer’s mandate is “to marshal, con-
serve, protect, hold funds, operate, and with the approval
of the Court, dispose of any wasting assets, wherever those
assets may be found, of Heartland” “for the benefit of the in-
vestors.” Agreed Order at para. 1, SEC v. Payne (S.D. Ind.
Aug. 21, 2000) (No. IP00-1265 C). A year later, Knauer
brought this action against the five broker dealers, charging
that they are liable to Heartland and JMS for a variety
of torts based upon the broker dealers’ relationship with
Payne and Danker: Counts I and II alleged that the broker

1
  Payne has since been convicted of mail fraud and money
laundering. Danker has been convicted of wire fraud and money
laundering. Both are serving lengthy prison terms.
4                                                    No. 02-3926

dealers are “controlling persons” liable for the wrongful con-
duct of Payne and Danker and for the sale of unregistered,
nonexempt securities by Payne and Danker pursuant to the
Securities and Exchange Act of 1934 and the Indiana Secur-
ities Act, Ind. Code § 23-2-1-1 et seq. Count III alleged that
the broker dealers are directly liable for breach of fiduciary
duty and fraud and vicariously liable for the fraudulent
and wrongful conduct of Payne and Danker under the doc-
trine of respondeat superior. Count IV alleged damages
under Indiana’s crime victims statute, Ind. Code § 34-24-3-
1, based on both direct and vicarious liability.2 Count V
alleged negligent supervision of the activities of Payne and
Danker by the broker dealers.
  The broker dealers moved to dismiss the complaint under
Fed. R. Civ. P. 12(b)(1) and 12(b)(6). They argued that the
receiver had no standing because he was improperly assert-
ing claims of the investors, and not claims of the entities on

2
    Ind. Code § 34-24-3-1. Damages in civil action
 If a person suffers a pecuniary loss as a result of a violation of
[certain statutes], the person may bring a civil action against the
person who caused the loss for the following:
      (1) An amount not to exceed three (3) times the actual
          damages of the person suffering the loss.
      (2) The costs of the action.
      (3) A reasonable attorney’s fee.
          ...
  In Tippecanoe Beverages, Inc. v. S.A. El Aguila Brewing Co., 833
F.2d 633 (7th Cir. 1987), we held that Ind. Code § 34-24-3-1 and
Ind. Code § 35-41-2-3(a) (“A corporation, limited liability company,
partnership, or unincorporated association may be prosecuted for
any offense; it may be convicted of an offense only if it is proved
that the offense was committed by its agent acting within the
scope of his authority.”) combine to form a statutory version of re-
spondeat superior, pursuant to which principals are liable for
offenses committed by an agent acting within the scope of his au-
thority.
No. 02-3926                                                  5

whose behalf he was appointed. In the alternative, the de-
fendants argued that the receiver’s claims were barred by
the equitable doctrine of in pari delicto, which prohibits a
plaintiff from maintaining a claim if the plaintiff himself
bears equal fault for the alleged injury, and that the
complaint failed to state a claim upon which relief could be
granted.
  The district court dismissed Counts I and II, agreeing
with the defendants that those claims belonged to the inves-
tors in Heartland and JMS, rather than to the Ponzi
entities themselves. The receiver does not appeal the
dismissal of those two counts. The district court concluded
that the receiver did have standing to assert Counts III, IV
and V, but nonetheless dismissed these counts under the
doctrine of in pari delicto. The district court held that these
claims were barred because the receiver had pleaded in his
complaint, “[s]imply put, [that] Payne, Danker, Smith, and
Brooks-Kiefer were Heartland and JMS,” leading to the
“inescapable conclusion that Heartland and JMS partici-
pated in the Ponzi scheme and knew of the conversion of
Heartland and JMS funds by Payne, Danker and others.”
District Ct. Order at 18, 16 (emphasis added). The receiver
appeals the dismissal of Counts III, IV and V.


                              II.
 We review a Fed. R. Civ. P. 12(b) dismissal de novo.
Dawson, 977 F.2d at 372.


                              A.
  Before considering the district court’s ground for dismis-
sal, we need to clarify exactly what claims are before us.
Perhaps in part because of the unusual nature of this case,
the receiver filed not only one lengthy complaint but incor-
porated by reference large portions of two additional com-
6                                                   No. 02-3926

plaints filed in other proceedings. Taken as a whole, this
pleading provides a plethora of detail about the alleged mis-
deeds of Payne, Danker, Heartland, JMS and other individ-
uals and entities involved in the Ponzi scheme. It is quite
significant, however, that the receiver is not pursuing all
claims that might have arisen from such a complex and
prolonged species of fraudulent activities.
   What claims is the receiver pursuing? For our purposes,
it is useful to think of Ponzi schemes as being comprised of
two phases. First, the schemer solicits and receives money
for investment, guaranteeing high returns while doing little
with the money to produce actual profits. While in this first
stage, the schemer may generate some income for himself
by charging a fee or paying himself a salary with the funds,
this “sales” step is not the source of most of his Ponzi gains.
After all, the Ponzi schemer is not content to enrich himself
modestly by extracting fees or salaries from the funds he
has solicited. Rather, the schemer realizes most of his gains
by appropriating large sums of money from the solicited
funds, the pace of the withdrawals accelerating as he is
ready to disband the Ponzi entity and make off with its as-
sets. This “embezzlement” step of the Ponzi scheme depletes
the Ponzi entity of resources, which are diverted to the
entity’s principal, the schemer.3
  The five counts of the instant Complaint can be mapped
along the lines of the two Ponzi phases. Counts I and II of
the Complaint involve the torts associated with illegal sales
of securities, and were dismissed by the district court.
While those dismissals were not appealed and are therefore
not before us, we believe that the district court was proba-
bly correct in concluding that Knauer, as receiver for
3
  We do not intend to imply that the two steps or phases of the
scheme occur at chronologically distinct points in the life of the
Ponzi scheme. Rather, it is likely that both sales and embezzle-
ments are occurring simultaneously. Some sales, however, must
precede diversion of funds; hence our two-phase analysis.
No. 02-3926                                                        7

Heartland and JMS, had no standing to pursue the Ponzi
sales claims. As we see it, Ponzi entities themselves are not
injured by the sales of securities. Even if Heartland and
JMS were arguably being “misused” by Payne and Danker,
this misuse, at the sales stage, resulted only in the fatten-
ing of the companies’ coffers.4 Any claim relating to the
fraudulent sales rightfully belongs to the wronged inves-
tors, and can be made by them against any one of Payne,
Danker, Heartland, JMS or other culpable person or entity,
including possibly the defendants here.
  Somewhat different rules are in effect for Counts III, IV
and V of the instant Complaint, which involve the embez-
zlement, rather than the sales, step of the Ponzi scheme.
The receiver alleges “that injury to Heartland occurred
when Payne and Danker misappropriated Heartland funds
that had previously been paid to Heartland by investors.”
Receiver’s Resp. to Mots. to Dismiss at 4, Record at 67. See
also Sept. 4, 2002 Transcript at 43 (“[Judge Tinder]: So the
harm to Heartland and JMS didn’t come from the sales, it
came from the embezzlement or taking of the funds by
Payne and Danker? [Counsel for Knauer]: That is correct.”).
As the district court again properly concluded, the diversion
of funds by Payne and Danker from Heartland and JMS did

4
   We do recognize that Heartland and JMS were made vulnerable
to liability as a result of their shareholders’ misconduct. And in a
different factual scenario, we might find such exposure to liability
a sufficient injury to accord faultless representatives of a corpora-
tion, whether a receiver or subsequent innocent shareholders,
standing to sue for the greater liability or deeper insolvency
created by earlier shareholders. See, e.g., Official Comm. of Un-
secured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 354 (3d Cir.
2001); Miller v. San Sebastian Gold Mines, 540 F.2d 807 (5th Cir.
1976). In a Ponzi scheme such as this one, however, where the
Ponzi fraud pervaded the entire entity at all relevant times, we
cannot find a justiciable injury. At least at the sales stage of the
Ponzi scheme, every dollar tortiously produced was revenue to
Heartland.
8                                               No. 02-3926

arguably constitute injuries to the Ponzi entities, giving
Knauer standing to pursue Counts III, IV and V. But the
next question is whether the equitable defense of in pari
delicto defeats these claims as asserted against the broker
dealer defendants.


                             B.
  Counts III and IV allege damages based on the broker
dealers’ role in Payne’s and Danker’s embezzlements, both
directly and vicariously under respondeat superior, while
Count V alleges that negligent supervision of Payne and
Danker by the broker dealers contributed to the embez-
zlements. The district court dismissed Counts III, IV and V
by applying the doctrine of in pari delicto. According to the
receiver, Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995),
demands a contrary outcome. It is worth describing Scholes
in some detail.
   In Scholes, we had before us another Ponzi scheme, this
one perpetrated by a Michael Douglas and his three
corporations. Douglas’s corporations formed limited
partnerships, into which investors were duped into entering
as limited partners. After Douglas and his operation were
derailed by the SEC, the district court appointed a receiver,
Steven Scholes, for Douglas and the corporations. By the
time Scholes v. Lehmann came before us, Scholes had
successfully recovered $12 million, most of it from property
in the possession of Douglas that Douglas had bought with
money siphoned from the corporations. In Scholes v.
Lehmann, Scholes sought to reach and recover additional
funds, from certain beneficiaries of Douglas’s largesse—his
ex-wife, an investor who had managed to profit from the
Ponzi scheme and five religious organizations—under an
Illinois fraudulent conveyance statute.
  We rejected two arguments raised by the Scholes defen-
dants. First, they disputed standing. See Scholes, 56 F.3d at
No. 02-3926                                                9

754 (“How, the defendants ask rhetorically, could the alleg-
edly fraudulent conveyances have hurt Douglas, who engi-
neered them, or the corporations that he had created, that
he totally controlled and probably . . . owned all the com-
mon stock of, and that were merely the instruments
through which he operated the Ponzi scheme?”). We found
that there was standing because Scholes was proceeding not
only on behalf of Douglas, but on behalf of corporate
entities. The corporations, as legally distinct persons, were
harmed by Douglas’s fraudulent conveyances. Id. (“The
corporations, Douglas’s robotic tools, were nevertheless in
the eyes of the law separate legal entities with rights and
duties. ”). As long as an entity is legally distinct from the
person who diverted funds from the entity, a receiver for
the entity has standing to recover the removed funds. Cf.
Troelstrup v. Index Futures Group, 130 F.3d 1274 (7th Cir.
1997) (distinguishing Scholes and finding no justiciable
injury when a perpetrator of a fraud removes money from
his own personal account rather than from an account in
the name of a legally distinct corporation). The diversion of
assets is a legally cognizable injury even if “[a]s sole
shareholder, [the Ponzi perpetrator] could lawfully have
ratified the diversion of corporate assets to noncorporate
purposes.” Scholes, 56 F.3d at 754.
  The Scholes court also considered the applicability of the
defense of in pari delicto. More precisely, the Scholes
defendants had argued “that the wrongdoer must not be
allowed to profit from his wrong by recovering property that
he had parted with in order to thwart his creditors,”
Scholes, 56 F.3d at 754. In other words, Douglas had made
the fraudulent conveyances to achieve an improper end (i.e.,
to put money beyond the reach of creditors), and should not
be allowed to undo them to secure a benefit for himself. We
rejected this argument as well, because Douglas himself did
not stand to benefit from the receiver’s suit—he was incar-
cerated and totally removed from association with the cor-
10                                               No. 02-3926

porations—and “the defense of in pari delicto loses its sting
when the person who is in pari delicto is eliminated.” Id.
“The corporations were no more Douglas’s evil zombies.
Freed from his spell they became entitled to the return of
the moneys . . . that Douglas had made the corporations
divert to unauthorized purposes.” Id.
  While Scholes may recommend a generous approach to-
ward certain lawsuits brought by corporate receivers, even
where the corporations they represent have been complicit
in illegal activities, both parties here acknowledge that we
must look to Indiana law to determine the rights of the
receiver in the present case. See O’Melveny & Myers v.
FDIC, 512 U.S. 79, 83, 88 (1994). While no Indiana cases
have addressed this precise situation, we find that related
cases help provide context to Scholes.
   “Since the rights and powers of a receiver with respect to
the property in his hands as such are not specifically de-
clared by statute the rules governing such rights and
powers are of equitable origin. . . . The appointment of a
receiver does not determine, or even affect the rights of the
parties, except so far as it preserves and retains control of
the property to answer final judgment.” 24 Indiana Law
Encyclopedia Receivers § 41 (citations omitted). “There can
be no doubt of the proposition that it is the general rule
that in the ordinary receivership, . . . the receiver can only
sue in the right of the corporation, and that he is subject to
all of the equities which would have been available against
it.” Marion Trust Co. v. Blish, 84 N.E. 814, 816 (Ind. 1908).
“[T]he receiver of a corporation is bound precisely as it is
bound and occupies the relation to the stockholders that the
corporation itself, if waging the suit in its own person,
would occupy. This is true, although the receiver represents
the creditors as well as the stockholders.” Id. at 817
(internal quotation marks and citation omitted).
  The rule that a receiver stands precisely in the shoes of
the corporation is, however, “subject to the exception that
No. 02-3926                                                11

the receiver so far represents the general creditors that he
may avoid transactions in fraud of their rights.” Id. at 816.
This exception allows receivers to avoid transactions that
violate the rights of creditors. See Hammond v. Cline, 84
N.E. 827, 828 (Ind. 1908) (“He takes over nothing but what
belongs to the corporation, except, in certain cases, where
the corporation is estopped by its fraud, he takes the right
to prosecute an action for an avoidance of the transaction
for the use of the general creditors.”); Franklin Nat. Bank
v. Whitehead, 49 N.E. 827 (Ind. 1908); see also 7 Indiana
Law Encyclopedia Corporations § 181 (“While generally he
or she is in no better position to bring an action than the
corporation would have been, he or she may sue or defend
in some circumstances where the corporation might have
been estopped by its own fraud.” (citations omitted)).
Scholes, which was decided under Illinois law, is an exam-
ple of the application of such an exception.
  The principal issue is whether we find more appropriate
here the general Indiana rule or the exception to that rule.
If the case before us involved the voiding of a fraudulent
conveyance, as in Scholes or the Indiana cases just cited, we
would likely apply Scholes and the Indiana law favoring
exceptional treatment of receivers in those circumstances.
This case, however, presents a different equitable align-
ment. The key difference, for purposes of equity, between
fraudulent conveyance cases such as Scholes and the
instant case is the identities of the defendants. The receiver
here is not seeking to recover the diverted funds from the
beneficiaries of the diversions (e.g., the recipients of
Douglas’s transfers in Scholes). Rather, this is a claim for
tort damages from entities that derived no benefit from the
embezzlements, but that were allegedly partly to blame for
their occurrence. In the equitable balancing before us, we
find Scholes less pertinent than the general Indiana rule
that the receiver stands precisely in the shoes of the
corporations for which he has been appointed.
12                                                   No. 02-3926

   “The doctrine known by the latin phrase in pari delicto
literally means ‘of equal fault.’ ” Theye v. Bates, 337 N.E.2d
837, 844 (Ind. App. 1975) (quoting Perma Life Mufflers, Inc.
v. Intern. Parts Corp., 392 U.S. 134, 135 (1968)). “The ex-
pression ‘in pari delicto’ is a portion of the longer Latin sen-
tence, ‘In pari delicto potior est conditio defendantis,’ which
means that where the wrong of both parties is equal, the
position of the defendant is the stronger.” Id. (quoting
W. M. Moldoff, Annotation, Purchaser’s Right To Set Up
Invalidity of Contract Because of Violation of State Securi-
ties Regulation as Affected by Doctrines of Estoppel or Pari
Delicto, 84 A.L.R.2d 479, 491). “Equity looks beneath rigid
rules to find substantial justice and has the power to
prevent strict rules from working an injustice.” 12 Indiana
Law Encyclopedia Equity § 3.
  Counts III and IV allege, essentially, that the relation-
ship between Payne and Danker and the defendants results
in liability for the defendants. Count V alleges that the
defendants were responsible for supervising Payne and
Danker, but failed in this responsibility. In sum, all of the
liability, according to the complaint, arises from the
employment or agency relationship between the broker
dealer defendants and Payne and Danker.5 In addition to
5
   The relationship between the primary wrongdoers and the de-
fendants in this case resembles Troelstrup v. Index Futures Group,
130 F.3d 1274 (7th Cir. 1997). In Troelstrup, a receiver sued a fu-
tures commission merchant through which the principal tortfeasor
had traded and maintained accounts. Similarly, the present case
is against broker dealers who had an otherwise non-Ponzi-related
relationship with Payne and Danker yet may have acted as inter-
mediaries in some of Payne’s and Danker’s Ponzi-related securi-
ties transactions. While we did not reach the in pari delicto ques-
tion in Troelstrup, and the opinion in that case distinguished
Troelstrup from Scholes principally on the ground that Troelstrup
did not involve a corporate receiver, we find instructive the fact
that the receiver in Troelstrup was not seeking to avoid a fraudu-
                                                   (continued...)
No. 02-3926                                                     13

the defendant broker dealers, however, there were other
companies that had employment and agency relationships
with Payne and Danker—namely, Heartland and JMS.
  We find that Heartland and JMS are charged with fault
at least equal to that of the broker dealers. Heartland and
JMS were very much at the forefront of the Ponzi scheme.
However, even if we could imagine that the broker dealers’
relationship with Payne and Danker aided the solicitation
of investments—and find plausible a suit by the defrauded
investors against the broker dealers on this basis—the
instant Complaint makes clear that the defendants’ involve-
ment in the Ponzi scheme as a whole was quite minor. See
Compl. at 9, para. 44 (alleging that Payne’s and Danker’s
sales activities “were not approved or authorized by the
brokerage firms”). Of course, there is no allegation whatso-
ever that the defendants were directly involved in the em-
bezzlements or benefitted from them.
  The basic equity is that a broker dealer, which apparently
had little to do even with the Ponzi scheme, should not be
liable to Heartland, which was deeply complicit in the
crimes, when both were employers and principals of Payne
and Danker. Payne and Danker were, while conducting
either the fraudulent sales or the embezzlements, more
closely associated with Heartland and JMS than with the
broker dealers. While, of course, the embezzlements did not
benefit Heartland and JMS—as we have stated, the
receiver here has standing because the Ponzi corporations
suffered a legal injury from the embezzlements—the
embezzlements did not benefit the broker dealers, either.
We do not see how the embezzlements could be said to have


(...continued)
lent transaction, but was pursuing a tort action similar to the one
here. As we will indicate, cases such as this one and Troelstrup
present the receiver in a somewhat different position than cases
such as Scholes.
14                                                   No. 02-3926

arisen from Payne’s and Danker’s relationship with the
broker dealers in a more cognizable way than from Payne’s
and Danker’s relationship to the Ponzi entities, so that the
brokers dealers could become liable to the Ponzi entities.6
  The receiver’s core argument is that Heartland and JMS
should be allowed to pursue claims against the broker deal-
ers because, as a receiver, he is somehow separated from
the past crimes of Payne, Danker, Heartland and JMS.
While that may be true, the extent of the separation, for
purposes of applying standing and in pari delicto principles,
is an equitable determination. Given the facts here, we do
not see how the fact that Heartland and JMS are repre-
sented by a receiver should alone force us to ignore the fact
that their nexus to Payne and Danker was far more imme-
diate than that of the broker dealers, and deprive the
broker dealers of the defense of in pari delicto. The doctrine
of in pari delicto thus applies to defeat the receiver’s claims.


                               III.
  For the reasons given above, the judgment of the district
court is AFFIRMED.




6
  Had the broker dealers been directly involved in the embezzle-
ments, or attained some tangible benefit from them, this would be
a different case. We are sensitive, as the district court was, that
in pari delicto is an affirmative defense and generally dependent
on the facts, and so often not an appropriate basis for dismissal.
We find it appropriate here, however, given the facts thoroughly
alleged in the complaint.
No. 02-3926                                         15

A true Copy:
      Teste:

                    ________________________________
                    Clerk of the United States Court of
                      Appeals for the Seventh Circuit




               USCA-02-C-0072—10-22-03
