Bass, Berry & Sims attorney Chris Lazarini discussed an adversary proceeding brought against a broker by a plaintiff seeking recovery of investment losses. After the plaintiff filed a FINRA arbitration, the broker filed a Chapter 7 bankruptcy action. The arbitration stayed, the plaintiff responded by challenging the dischargeability of the broker's alleged debt. Denying the broker's motion for judgment on the pleadings, the bankruptcy court ruled the broker/debtor could not automatically escape the potential debt because the court could decide the merits of plaintiff's state securities law claims under 11 U.S.C. §523(a)(19). 

Chris provided the analysis for Securities Litigation Commentator (SLC). The full text of the analysis is below and used with permission from the publication.

Butler, In Re: Dorsch vs. Butler, No. 17-22141, Adv. Proc. No. 17-02169 (E.D. Wis., Bankr., 11/6/17) 

A debtor may not escape a debt in bankruptcy if the debt arises from false pretenses, false representations or actual fraud; or from fraud or defalcation in a fiduciary capacity, embezzlement or larceny; or from violating a securities law resulting in a judgment, settlement or administrative order. 

In 2014, Plaintiff opened an account with Butler as her broker and made a cash deposit. Butler told Plaintiff he was developing a long-term investment strategy for selected clients and invested her funds in what Plaintiff alleged to be aggressive, high-risk stocks. After the purchases had been made, Butler asked Plaintiff to sign a wealth management agreement. Concerned about her investments, Plaintiff refused and filed a complaint with the Wisconsin Department of Financial Institutions ("Department"). After reviewing the matter, the Department sent a letter to Butler's counsel "requesting" that Butler and his firm refund all advisory fees charged and "consider" settling with Plaintiff on her investment losses. Butler refunded the advisory fees, but an agreement could not be reached on the investment losses. Plaintiff filed a FINRA arbitration, which was stayed when Butler filed a Chapter 7 bankruptcy action. Plaintiff then filed this adversary proceeding to challenge the dischargeability of Butler's "debt" to her, attaching her FINRA Statement of Claim to her complaint. Butler answered, with a counterclaim for declaratory judgment, and moved for judgment on the pleadings. 

The Court examines whether the "debt" is non-dischargeable under 11 U.S.C. §523(a)(2) (false pretenses, false representation or actual fraud), §523(a)(4) (fraud or defalcation in a fiduciary capacity) or §523(a)(19) (violation of securities law resulting in a judgment, settlement agreement or order). First, Plaintiff failed to state a claim for false pretenses, false representation or fraud under §523(a)(2). The only representation Butler was alleged to have made is that he was developing a long-term investment strategy. On the face of the pleadings, the Court finds this statement was not false or made with reckless disregard for the truth or with the intent to deceive Plaintiff. Next, although the Court finds Butler was a fiduciary under §523(a)(4), the defalcation standard is not met because Butler's investment in publicly traded securities was neither an intentional wrong nor criminally reckless.

Finally, turning to §523(a)(19), the Court finds Plaintiff stated a claim for violation of the state securities laws, but finds the Department's letter requesting that Butler consider a settlement with Plaintiff insufficient to meet the judgment, settlement agreement or order requirement. However, because §523(a)(19) allows for the judgment or order to be entered in a federal or state judicial proceeding, including a bankruptcy proceeding, after the Chapter 7 petition has been filed, the Court denies Butler's motion for judgment on the pleadings, allowing Plaintiff to move forward with her adversary claim. 

Before getting to the merits of Butler's motion, which requires it to accept as true all well-pleaded allegations in Plaintiff's "pleadings," the Court questions whether it should consider the allegations in Plaintiff's FINRA Statement of Claim, which she attached to her complaint. The Court says it is a "debatable" issue, but because Butler addressed the FINRA claims in his pleadings, the Court "assumes" the allegations were appropriately incorporated into the Complaint.