United States Bankruptcy Court, D. New Jersey
In re Stephen E. Hill and Lauri Robin Hill, Debtors.
Stephen E. Hill and Lauri Robin Hill, Defendants. Cornelius Floyd, Plaintiff, Adv. Pro. No. 11-1746 (MS)
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Nachamie Spizz Cohen & Serchuk, PC, Barton Nachamie, Esq., New York, NY, Jeffrey L. Rosenberg & Associates, LLC, Jeffrey L. Rosenberg, Esq., Old Westbury, NY, for Plaintiff.
Stephen E. Hill, Lauri Robin Hill, Upper Saddle River, NJ, Debtors/Defendants Pro Se.
HONORABLE MORRIS STERN, Bankruptcy Judge
Plaintiff Cornelius Floyd (" Floyd" ) moves for " partial summary judgment," excepting a purported $3,200,000 debt from the bankruptcy discharge of Defendant-Chapter 7 Debtor Stephen E. Hill (" Hill" ), pursuant to 11 U.S.C. § 523(a)(19).
At the heart of Floyd's motion is a " Summary Order," entered on November 30, 2010 by the Bureau of Securities of the State of New Jersey pursuant to N.J.S.A. § 49:3-47 et seq. (the New Jersey version of the Uniform Securities Law, " NJUSL" or more generally, " USL" ). This comprehensive twenty-nine page ex parte Order made detailed findings including (but not limited to) specific acts of Hill, a licensed investment advisor, associated with the sale of securities for a real estate transaction (" Hackensack Park Plaza" ) and a venture known as " Snap-on-Smile" (a dental appliance invention). Floyd (identified as " C.F." in the Order), a customer of Hill, had purchased securities in these ventures through Hill.
The Bureau's investigative findings generated conclusions of law regarding Hill's compliance with securities regulations (conclusions not per se actionable by individual investors). Inter alia, it was determined
that Hill had (i) engaged in dishonest or unethical practices in the securities business, (ii) employed a scheme to defraud a client, (iii) caused false records to be created and submitted to regulatory authorities, and (iv) made untrue statements of material fact or omitted material facts in the offer or sale of securities. Hill's various investment advisor registrations were accordingly revoked and he was assessed a $210,000 civil penalty due the regulator. There was no challenge to or appeal from the Order.
Before Hill's bankruptcy and the issuance of the Summary Order, Floyd had initiated two actions seeking damages from Hill and others. On May 4, 2010 Floyd (and others) filed a complaint in the United States District Court for the District of New Jersey, targeting Hill and others for federal securities law violations as well as other claims associated with the Hackensack Park Plaza offering. Floyd also initiated a similar case on May 26, 2010 in the United States District Court for the Southern District of New York against Hill and others, arising out of the Snap-on-Smile investment. Both cases were stayed as to Hill on December 20, 2010 when he filed his Chapter 7 bankruptcy petition. Thereafter, on April 29, 2011, Floyd filed the immediate adversary proceeding seeking both a determination of liability and exception to discharge per 11 U.S.C. § 523(a)(2)(A) (common law fraud), (a)(4) (fraud or defalcation while acting in a fiduciary capacity), (a)(6) (willful and malicious injury to property), (a)(13) (payment of an order of restitution per title 18, United States Code), and (a)(19). Only the § 523(a)(19) counts (for federal securities law violations pertaining to Hackensack Park Plaza and Snap-on-Smile) remain at issue, given the plaintiff's waiver of trial and complete reliance on his limited summary judgment motion. The motion, in turn, depends almost exclusively on the Summary Order and, presumably, the purported preclusive effect of its factual findings (not conclusions of law).
This adversary proceeding, through the immediate pending summary judgment
motion of the plaintiff, raises two basic issues:
(i) Does the Bankruptcy Code provision excepting from discharge a Chapter 7 debtor's debts for securities law violations, 11 U.S.C. § 523(a)(19), deny the bankruptcy court authority to enter the initial substantive judgment for those violations (as distinguished from a resulting judgment for exception to discharge based upon a persisting judgment, decree, order or settlement)?
(ii) Assuming the bankruptcy court is authorized to enter that initial substantive judgment, does the New Jersey Bureau of Securities' " Summary Order" (revoking the debtor-investment advisor's various securities registrations and fining him), as augmented by summary judgment motion submissions, preclusively establish facts pertinent to the debtor's violation of securities law and his debt to this proceeding's investor-plaintiff, as well as that debt's § 523(a)(19) exception to discharge?
The court finds that (i) it has authority to enter the initial substantive judgment, (ii) the findings of fact of the Summary Order are not preclusive in this proceeding, and (iii) plaintiff's summary judgment motion is denied, i.e., no substantive judgment nor judgment for exception to discharge is to be entered against the debtor. Accordingly, since the plaintiff has waived his right to go forward with trial, the plaintiff's complaint shall be dismissed.
II. BANKRUPTCY COURT'S GENERAL JURISDICTION OVER ADVERSARY PROCEEDING AND STANDARD TO ADJUDGE MOTION.
Bankruptcy court jurisdiction in this proceeding is granted pursuant to 28 U.S.C. § 1334(b) and this District's Standing Orders of Reference of July 23, 1984 and September 18, 2012. This is a core proceeding under 28 U.S.C. § 157(b)(2)(A), (I) and (O). This court is thus authorized to hear and determine the plaintiff's summary judgment motion.
B. Summary Judgment Standard.
Summary judgment is appropriate when the court, viewing the facts in the light most favorable to the nonmoving party, finds that there is no genuine issue of material fact, and the moving party is entitled to judgment as a matter of law. Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986); Fed. R. Bankr.P. 7056, Fed.R.Civ.P. 56(a). At summary judgment " the judge's function is not to weigh the evidence and determine the truth of the matter, but to determine whether there is a genuine issue for trial." Josey v. John R. Hollingsworth Corp., 996 F.2d 632, 637 (3d Cir.1993). Use of summary judgment in bankruptcy adversary proceedings is an efficient means to preserve limited estate assets. It " is properly regarded not as a disfavored procedural shortcut, but rather as an integral part of the Federal Rules as a whole, which are designed ‘ to secure the just, speedy and inexpensive determination of every action.’ " Celotex Corp., 477 U.S. at 327, 106 S.Ct. 2548 (quoting Fed.R.Civ.P. 1).
III. THIS COURT'S AUTHORITY TO ADJUDICATE LIABILITY AND DAMAGES FOR SECURITIES LAW VIOLATIONS WITHIN A § 523(a)(19) -BASED ADVERSARY PROCEEDING.
A. Text of § 523(a)(19).
Section 523(a)(19) in its original form was added to the Bankruptcy Code as part of the Sarbanes-Oxley Act of 2002. Sarbanes-Oxley was a swift reaction to what
congressional reports refer to as the " Enron collapse." As modified in 2005 (see emphasis), the section is as follows:
(a) A discharge under section 727 ... of this title [11 U.S.C.] does not discharge an individual debtor from any debt—
(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 section contains no language limiting the purview of the bankruptcy court. However, before the 2005 amendment the exception to discharge " may have" applied solely to a securities law-based debt memorialized in a prepetition judgment, order, decree or settlement. 4 Alan N. Resnick & Henry J. Sommer, Collier on Bankruptcy § 523.29 (16th ed. 2013) (hereinafter " Collier" ).
B. Legislative History.
The 2002 legislative history of § 523(a)(19) includes the following statements:
By Mr. LEAHY (for himself, Mr. DASCHLE, Mr. DURBIN, and Mr. HARKIN):
S. 2010. a bill ... to disallow debts incurred in violation of securities fraud laws from being discharged in bankruptcy.... [Emphasis added.]
148 Cong. Rec. S1783-01, *S1785 (daily ed. March 12, 2002) (statement of Sen. Leahy), 2002 WL 384616, *6.
Section 4 of this bill would amend the Bankruptcy Code to make judgments and settlements based upon securities law violations non-dischargeable, protecting victims' ability to recover their losses. 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 perpetrate securities fraud after a government unit or private suit results in a judgment or settlement against the wrongdoer.
...Under current laws, State regulators are often forced to " reprove" their fraud cases in bankruptcy court to prevent discharge because remedial statutes often have different technical elements than the analogous common law causes of action. Moreover, settlements may not have the same collateral estoppel effect as judgments obtained through fully litigated legal proceedings. In short, with their resources already stretched to the breaking point, these State regulators have to plow the same ground twice in securities fraud cases. By ensuring securities fraud judgments
and settlements in State cases are non-dischargeable, precious state enforcement resources will be preserved and directed at preventing fraud in the first place. [Emphasis added.]
148 Cong. Rec. S1783-01, *S1787 (daily ed. March 12, 2002) (statement of Sen. Leahy), 2002 WL 384616, *8.
This provision would amend the Federal bankruptcy code to make judgments and settlements arising from state and federal securities law violations brought by state or federal regulators and private individuals non-dischargeable. Current bankruptcy law may permit wrongdoers to discharge their obligations under court judgments or settlements based on securities fraud and securities law violations. This loophole in the law should be closed to help defrauded investors recoup their losses and to hold accountable those who perpetrate securities fraud. [Emphasis added.]
148 Cong. Rec. S1783-01, *S1790 (daily ed. March 12, 2002) (Sectional Analysis: Corporate and Criminal Fraud Accountability Act of 2002), 2002 WL 384616, *16.
Section 803.— Debts nondischargeable if incurred in violation of securities fraud laws
... The section, by its terms, applies to both regulatory and more traditional fraud matters, so long as they arise under the securities laws, whether federal, state, or local.
This provision is meant to prevent wrongdoers from using the bankruptcy laws as a shield and to allow defrauded investors to recover as much as possible. To the maximum extent possible, this provision should be applied to existing bankruptcies. The provision applies to all judgments and settlements arising from state and federal securities laws violations entered in the future regardless of when the case was filed. [Emphasis added.]
148 Cong. Rec. S7418-01, *S7418 (daily ed. July 26, 2002) (Legislative History of Title VIII of HR 2673): The Sarbanes-Oxley Act of 2002; Section-by-Section Analysis and Discussion of the Corporate and Criminal Fraud Accountability Act (Title VIII of H.R. 2673), 2002 WL 1731002, *2.
As part of the broad sweep of Bankruptcy Code amendments included in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (" BAPCPA" ), the preamble language (" before, on, or after the date on which the petition was filed" ) was added to § 523(a)(1 9)(B). The limited legislative history of the amendment is as follows:
Sec. 1404. Debts Nondischargeable If Incurred in Violation of Securities Fraud Laws. Bankruptcy Code section 523(a)(19) makes certain debts nondischargeable that result from the violation of Federal securities law, state securities law, or any regulation or order issued under such Federal or state securities law nondischargeable. Section 1404 amends Bankruptcy Code section 523(a)(19)(B) to provide that it applies to such debts that result before, on, or after the date on which the petition was filed from any judgment, order, consent order, decree, settlement agreement, or from any court or administrative order for damages or for other specified payments owed by the debtor. Section 1404 is effective as of July 30, 2002. [Emphasis added.]
H.R. Rep. 109-31(I) (2005) reprinted in 2005 U.S.C.C.A.N. 88, 2005 WL 832198, *212. As to retroactive application of the 2005 amendment to the original adoption date of § 523(a)(19) (i.e., July 30, 2002), see In re Weilein, 328 B.R. 553, 555 (Bankr.N.D.Iowa 2005).
C. Case Law.
There is now substantial disagreement among courts regarding the substantive area in which the bankruptcy court can adjudicate § 523(a)(19) claims. Some courts deny bankruptcy court jurisdiction to adjudicate liability and damages for violation of securities law. That denial persists, notwithstanding the 2005 amendment and the absence of any statutory language limiting bankruptcy court authority to enter a substantive judgment. Under this narrow view of jurisdiction the bankruptcy court would be relegated to applying issue preclusion in those (a)(19) claims brought before it. See generally Jordan Factor, Making Crooks Pay: The Path to Nondischargeable Securities Judgments , 41 Colo. Law. Mar. 2012, at 47. Other courts have held that the bankruptcy court can fully adjudicate liability, damages and exception to discharge in a § 523(a)(19)-based adversary proceeding. Under either view of
jurisdiction, these causes may be determined in the bankruptcy court or in another court of competent jurisdiction.
As indicated earlier, nothing in the current text of the (a)(19) exception to discharge ousts the bankruptcy court of jurisdiction or adjudicatory authority to reach the substance of securities law violations. Nevertheless, the 2002 legislative history principally rails against existing judgments or settlements being avoided in later-filed bankruptcy cases.  Acceding to the purported import and effect of this emphasis for present purposes only, the substance of the exception to discharge in 2002 may have been a securities law violation evidenced by a judgment, order or decree as of the petition date. The " debt" at issue under this view would have been for violation of securities law which " results from" such a prepetition judgment, order, consent order or decree.
Whether Sarbanes-Oxley was truly intended to be so temporally limited remains an imponderable. Imposing such a limitation surely opened or left open obvious " loopholes" for securities law violators to slip through in bankruptcy. By way of illustration (here and recurrently), the following is a factual setting which reflects a common securities law violation scenario and has characteristics of the immediate proceeding. Frequently, state securities law (USL) judgments, orders and decrees are but a first step (traditionally prompted by a state securities regulator in an administrative proceeding) in a two-step process toward securing restitution and other damages for individual investors. The administrative proceeding is often based upon USL violations for the sale of unregistered securities and/or sale of securities by ...