On an issue where the circuits are split, Bankruptcy Judge Kathleen H. Sanberg of Minneapolis sided with the majority and held that “only a debt traceable to a securities law violation committed by a debtor [can be held nondischargeable under] Section 523(a)(19).”
Section 523(a)(19)(A)-(B) provides that a debt of an individual is nondischargeable if it “is for . . . violation of any” state or federal securities law and “results . . . from . . . any judgment” by a state or federal court.
The debtor was a so-called net winner in a Ponzi scheme. He had invested less than $3,000 and managed to take out more than $140,000 before the Ponzi scheme collapsed.
In a suit in federal district court against the corporate operator of the Ponzi scheme, the Securities and Exchange Commission alleged violations of the ’33 and ’34 Acts. The Ponzi-schemer consented to judgment in favor of the SEC, including an injunction prohibiting violations of securities laws and the appointment of a receiver.
The individual who was a net winner was not a defendant in the SEC action, nor did he participate in the suit.
Later, the receiver brought a so-called clawback action against the net winner in district court alleging receipt of fraudulent transfers under state law. The receiver did not allege that the net winner had himself violated securities laws. With prejudgment interest, the district court entered judgment for about $190,000.
The net winner filed a chapter 7 petition, and the holder of the judgment filed an adversary proceeding to declare that the debt was nondischargeable under Section 523(a)(19). The complaint did not allege that the debtor had himself violated securities laws.
Both sides filed motions for summary judgment. In her November 9 opinion, Judge Sanberg explained how the judgment creditor argued that “a debtor does not need to be personally liable for a securities law violation, so long as a securities law violation led to the debt at issue.”
Judge Sanberg laid out the circuit split. The judgment creditor relied on Lunsford v. Process Techs. Servs., LLC (In re Lunsford), 848 F.3d 963 (11th Cir. 2017). To read ABI’s report on Lunsford, click here.
Judge Sanberg described Lunsford as holding “that the scope of Section 523(a)(19) is not limited to debts arising from a debtor’s own violation of securities laws. The Eleventh Circuit reasoned that the text and structure of Section 523(a)(19) prevents discharge irrespective of debtor conduct, so long as the debt is caused by a securities violation.” [Note: Lunsford was a 2/1 decision on that issue.]
Seeking dismissal for failure to state a claim, the debtor relied on the Collier treatise and opinions by the Ninth and Tenth Circuit holding to the contrary. See Okla. Dep’t of Sec. v. Wilcox (In re Wilcox), 691 F.3d 1171 (10th Cir. 2012); Sherman v. SEC (In re Sherman), 658 F.3d 1009 (9th Cir. 2011), abrogated on other grounds by Bullock v. BankChampaign, N.A., 569 U.S. 267 (2013).
Judge Sanberg described the Ninth Circuit as holding “that Section 523(a)(19) only prevents the discharge of a debt for a securities violation when the debtor is directly responsible for the violation.” Quoting the Tenth Circuit, she said that “Congress intended to ‘penalize the perpetrators of such schemes by denying them relief from their debts.’” Wilcox, supra, 658 F.3d at 1175-1176.
Persuaded by the Ninth and Tenth Circuits, Judge Sanberg held “that only a debt traceable to a securities law violation committed by a debtor is subject to Section 523(a)(19).”
Applying the law to the facts of the case, Judge Sanberg said that the judgment “did not result from the SEC Action, but from an entirely different action.” More specifically, she said that the $190,000 judgment directed the debtor “to repay his net winnings from the Ponzi scheme because the transfers were fraudulent under the [state fraudulent transfer law], and not because Defendant violated any securities laws.”
If the law were otherwise, Judge Sanberg said, it would “swoop up innocent debtors and preclude the discharge of debts for securities violations committed by others. And the fact that courts must construe exceptions to discharge narrowly and in favor of a debtor adds additional weight to this conclusion.”
Judge Sanberg dismissed the claim because the complaint did “not allege that [the debtor] had a judgment entered against him finding that he violated any securities laws, which is required for the debt to be nondischargeable under Section 523(a)(19)(A)(i).”
On an issue where the circuits are split, Bankruptcy Judge Kathleen H. Sanberg of Minneapolis sided with the majority and held that “only a debt traceable to a securities law violation committed by a debtor [can be held nondischargeable under] Section 523(a)(19).”
Section 523(a)(19)(A)-(B) provides that a debt of an individual is nondischargeable if it “is for . . . violation of any” state or federal securities law and “results . . . from . . . any judgment” by a state or federal court.
The debtor was a so-called net winner in a Ponzi scheme. He had invested less than $3,000 and managed to take out more than $140,000 before the Ponzi scheme collapsed.
In a suit in federal district court against the corporate operator of the Ponzi scheme, the Securities and Exchange Commission alleged violations of the ’33 and ’34 Acts. The Ponzi-schemer consented to judgment in favor of the SEC, including an injunction prohibiting violations of securities laws and the appointment of a receiver.
The individual who was a net winner was not a defendant in the SEC action, nor did he participate in the suit.