Making Crooks Pay: the Path to Nondischargeable Securities Judgments
| Publication year | 2012 |
| Pages | 47 |
| Citation | Vol. 41 No. 3 Pg. 47 |
2012, March, Pg. 47. Making Crooks Pay: The Path to Nondischargeable Securities Judgments
March 2012
Vol. 41, No. 3 [Page47]
Business Law articles are sponsored by the CBA Business Law Section to apprise members of current substantive law. Articles focus on business law topics for the Colorado practitioner, including antitrust, bankruptcy, business entities, commercial law, corporate counsel, financial institutions, franchising, and securities law.
Coordinating Editors
Trygve E. Kjellsen of Lathrop and Gage LLP, Denver-(720) 931-3145, tkjellsen@lathropgage.com; David P. Steigerwald of Sparks Willson Borges Brandt and Johnson, P.C., Colorado Springs-(719) 475-0097, dpsteig@sparkswillson.com; Curt Todd, Denver-(303) 955-1184, ctodd@templelaw.comcastbiz.net (Bankruptcy Law)
About the Author
About the Author Jordan Factor is an attorney at Allen and Vellone, P.C. His practice focuses on commercial and securities litigation, including the representation of investors in bankruptcy adversary proceedings, district court litigation, and FINRA arbitrations. He also represents creditors in main bankruptcy cases-(303) 534-4499, jfactor@allen-vellone.com.
By analyzing two leading bankruptcy cases that take opposing views on the subject, this article describes the procedures for obtaining a post-petition securities judgment.
udgments for securities law violations are not dischargeable in bankruptcy.(fn1) Since 2005, federal law has authorized creditors to obtain nondischargeable securities judgments even after the debtor has filed a bankruptcy petition. This change in law has introduced considerable uncertainty into bankruptcy adversary proceedings while courts and litigants struggle to determine the appropriate procedure for obtaining a post-petition securities judgment.
Two opposing views predominate. According to some courts, bankruptcy judges have jurisdiction to enter a judgment for a securities violation; therefore, the debtor's liability may be litigated in a bankruptcy adversary case. Other courts hold that Congress expressly denied such jurisdiction to bankruptcy courts; therefore, the adversary case must be held in abeyance while the creditor pursues a judgment in state court or federal district court. The time and cost expended to obtain a securities judgment, the rules of procedure that govern the pursuit of such a judgment, and the identity of the trier of fact are all implicated by this jurisdictional conundrum. This article reviews the leading jurisprudence in the area and provides an explanation and analysis of the relevant legal issues.
Overview of § 523(a)(19)
Section 523(a)(19) was adopted as part of the Sarbanes-Oxley Act of 2002, and was intended to serve the overall purpose of the Act, which was to "address systemic and structural weaknesses . . . revealed in . . . a breakdown in corporate financial and broker-dealer responsibility."(fn2) The function of § 523(a)(19) within the overall statutory scheme of Sarbanes-Oxley is to "amend the Bankruptcy Code to make judgments and settlements based upon securities law violations non-dischargeable, protecting victims' ability to recover their losses."(fn3) According to the Senate Committee report:
Current bankruptcy law may permit such wrongdoers to discharge their obligations under court judgments or settlements based on securities fraud and other securities violations. This loophole in the law should be closed to help defrauded investors recoup their losses and to hold accountable those who violate securities laws after a government unit or private suit results in a judgment or settlement against the wrongdoer.(fn4)
Senator Leahy, the author of the provision, emphasized that § 523(a)(19) "is meant to prevent wrongdoers from using the bankruptcy laws as a shield and to allow defrauded investors to recover as much as possible."(fn5)
Under § 523(a)(19) an individual debtor cannot obtain a discharge of any debt that:
(A) is for-
(i) the violation of any of the Federal securities laws (as that term is defined in section 3(a)(47) of the Securities Exchange Act of 1934), any of the State securities laws, or any regulation or order issued under such Federal or State securities laws; or
(ii) common law fraud, deceit, or manipulation in connection with the purchase or sale of any security; and
(B) results, before, on, or after the date on which the petition was filed, from-
(i) any judgment, order, consent order or decree entered in any Federal or State judicial or administrative proceeding;
(ii) any settlement agreement entered into by the debtor; or
(iii) any court or administrative order for any damages, fine, penalty, citation, restitutionary payment, disgorgement payment, attorney fee, cost, or other payment owed by the debtor.
The statute is divided into two principal subsections. Subsection A describes the content of the underlying conduct by the debtor, namely violation of state or federal securities laws or common law fraud in connection with a securities transaction. Subsection B requires that the debt be memorialized in a judgment, order, or settlement agreement. Both subsections have engendered controversy.
By its terms, Subsection A appears to be rather broad. By incorporating § 3(a)(47) of the Securities Exchange Act of 1934, § 523(a)(19)(A) encompasses any violation of the Securities Act of 1933, the Securities Exchange Act of 1934, the Public Utility Holding Company Act of 1935, the Trust Indenture Act of 1939, the Investment Company Act of 1940, the Investment Advisers Act of 1940, or the Securities Investor Protection Act of 1970. Therefore, even strict liability offenses such as sales of unregistered securities,(fn6) control person liability,(fn7) filing false registration statements,(fn8) or providing a misleading prospectus(fn9) arguably are encompassed by Subsection A. A creditor who lost money in an unregistered security might hold a nondischargeable claim.
Existing case law does not begin to define the scope of Subsection A. Some commentators take the statute at face value and assert that any debt arising from any violation of any federal or state securities law is, in fact, nondischargeable.(fn10) Others read the statute more narrowly, claiming that only the U.S. Securities and Exchange Commission (SEC) or other regulatory agency can obtain a judgment, order, or settlement of a securities law "violation."(fn11) Exploring the range of circumstances to which Subsection A might apply is beyond the scope of this article. Instead, this article focuses on the difficulties presented by Subsection B.
In its original incarnation in Title VIII of the Sarbanes-Oxley Act, § 523(a)(19)(B) contained only the words "that results from." It did not employ the phrase "before, on, or after the date on which the petition was filed." Therefore, a debt was nondischargeable only if it resulted from a pre-petition judgment, order, or settlement agreement. Courts enforced the provision accordingly.(fn12) A creditor who failed to obtain a pre-petition judgment had no recourse under § 523(a)(19). However, thereafter, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). As part of BAPCPA, Congress amended Subsection B to read "results, before, on, or after the date on which the petition was filed, from. . . ."(fn13) Through this amendment, Congress included post-petition securities judgments within the scope of § 523(a)(19).
An obvious question thus arises: How does a creditor obtain a post-petition securities judgment? The filing of a petition triggers an automatic stay of all litigation against the debtor outside the bankruptcy court.(fn14) Generally, there are only two mechanisms for obtaining a post-petition judgment against a debtor: (1) obtain relief from the automatic stay by order of the bankruptcy court;(fn15) or (2) file an adversary proceeding against the debtor in bankruptcy court.(fn16) Courts are divided over which procedure is appropriate and proper for the pursuit of a post-petition securities judgment.(fn17)
The central point of disagreement is whether Congress intended bankruptcy courts to have jurisdiction to enter securities judgments under § 523(a)(19). There are two leading cases nationally on this question, In re Chan(fn18) and Faris v. Bahram Amir Jafari (In re Bahram Amir Jafari).(fn19) No U.S. District Court or U.S. Court of Appeals decision has analyzed the issue in any detail. Without any controlling authority, bankruptcy court litigants are subject to the conflicting interpretations of bankruptcy judges.
The Chan Case
Triggered by a...
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