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Discharge Exception for Violation of Securities Laws Does Not Apply to Violations by a Third Party

By Karl Johnson posted 12-22-2021 20:54

Co-Editors in Chief: Alex Beeby, Larkin Hoffman and ;David M. TanabeWinthrop & Weinstine
Contributing Editors: David M. Tanabe and Karl J. Johnson, Taft Stettinius & Hollister LLP

In Nationwide Judgment Recovery, Inc. v. Simons (In re Simons), Ch. 7 Case No. 20-40631, Adv. No. 21-04027, 2021 WL 5225940 (Bankr. D. Minn. Nov. 9, 2021), Judge Sanberg held that § 523(a)(19)(A)(i) does not apply to a debtor that has not been found to have violated securities laws and that the plaintiff failed to present evidence that the debtor purchased or sold securities as required under § 523(a)(19)(A)(ii). 

Simons was a net winner in a Ponzi scheme perpetrated by an entity that consented to judgment in favor of the SEC for violation of the Securities Act of ’33. The court-appointed receiver of the entity prevailed on state law fraudulent transfer actions against all net winners, including Simons. 

A few years after judgment was entered against him for fraudulent transfer, Simons filed a voluntary petition under chapter 7 and the receiver filed  a complaint to except the judgment from discharge pursuant to § 523(a)(19). The defendant filed a motion for summary judgment arguing that the complaint fails to plead that he violated any securities laws or bought or sold any securities. The receiver argued that the fraudulent transfer judgment relates back to the SEC action against the Ponzi scheme perpetrator or, in the alternative, that the fraudulent transfer resulted from common law fraud in connection with Simon’s purchase or sale of securities.

Noting that the case raises a question of first impression in the Eighth Circuit, Judge Sanberg analyzed the circuit split on  whether a debt traceable to a securities law violation that was not committed by the debtor falls under § 523(a)(19)(A)(i). See Lunsford v. Process Techs. Servs., LLC (In re Lunsford), 848 F.3d 963 (11th Cir. 2017) (stating that § 523(a)(19) applies to violations of securities laws by a third party); Okla. Dep’t of Sec. ex rel. Faught v. Wilcox, 691 F.3d 1171 (10th Cir. 2012); Sherman v. SEC (In re Sherman), 658 F.3d 1009 (9th Cir. 2011) (holding that §523(a)(19) applies only when the debtor is directly responsible for the violation).  

In agreeing with the Ninth and Tenth Circuits, Judge Sanberg reviewed the legislative history and held that “[t]he basic question [under § 523(a)(19)(A)(i)] is whether the underlying judgment is ‘for the violation’ of any securities law” (emphasis added), not whether a fraudulent transfer judgment could be traced to a securities violation committed by a non-debtor. Judge Sanberg noted that holding otherwise would be contrary to the Eighth Circuit’s directive that exceptions to discharge be construed narrowly.

For § 523(a)(19)(A)(ii), Judge Sanberg held that the plaintiff failed to show that the fraudulent transfer was in connection with the purchase or sale of securities.

Because § 523(a)(19) does not apply to a non-debtor’s violation of securities law and the plaintiff failed to prove that the defendant purchased or sold securities, Judge Sanberg granted summary judgment in favor of the defendant.