11 U.S.C. §523(a)(19), which was part of the Sarbanes-Oxley Act of 2002, states that a discharge [in bankruptcy] does not discharge an individual debtor from any debt that
(A) is for:
(i) the violation of any of the Federal securities laws…, 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 [in bankruptcy] 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.
In re: Behrends, No. 15-1420, (10th Cir. Nov. 14, 2016)(appeal from In re: Behrends, No. 14-cv-03247 (D. Colo. September 30, 2015), involved a proceeding in a Chapter 7 bankruptcy whereby a creditor had obtained a FINRA arbitration award against the debtor for selling “$623,560.53 worth of five highly speculative securities offerings which [they] represented as suitable for retirees like Claimants who were looking for safe income producing investments.” https://www.ca10.uscourts.gov/opinions/15/15-1420.pdf. Claimants also maintained in the arbitration that the offerings were “’non-exempt public securities offerings conducted in violation of state and federal securities laws’ which were ‘the subject of SEC enforcement actions for fraud in the sale of securities.” Id. Their FINRA statement of claim asserted breach of fiduciary duty, fraud, violation of the Colorado Securities Act, violation of the Texas Securities Act, and negligence. Behrends filed an answer to the FINRA arbitration, but did not appear at the scheduled hearing even though he had notice. The FINRA panel concluded that the claimants had proved both liability and damages and issued a written Award stating that there were “multiple violations of Colorado state and federal securities law…” and finding Behrends jointly and severally liable for compensatory damages, as well as solely liable for a portion of compensatory damages.
Behrends thereafter filed his Chapter 7 bankruptcy case. The bankruptcy court granted claimants relief from the automatic stay, and plaintiffs confirmed the judgment in Colorado state district court. Behrends did not oppose confirmation of the award. Claimants then filed an adversary proceeding in the bankruptcy court seeking to have the debt declared non-dischargeable under 11 U.S.C. § 523(a)(19).
The bankruptcy court found both requirements of (a)(19) to be met, and that collateral estoppel barred it from reconsidering the merits of the plaintiffs’ FINRA claim. Behrends appealed. The Tenth Circuit affirmed that the debt was non-dischargeable in bankruptcy. Among the Tenth Circuit’s findings was that (a)(19) does not require the securities violation to be “actually litigated,” as Congress departed from the common-law understanding of collateral estoppel and issue preclusion principles. Section 523(a)(19) “permits a determination of nondischargability based on ‘any judgment,’ (emphasis added).” Id.; See also, Tripodi v. Welch, 810 F.3d 761, 766-67 (10th Cir. 2016).
Behrends also challenged the finding because he claimed the FINRA arbitration award was not sufficient to show a securities law violation, including which securities law he violated, the acts or omissions on which the violations are based, which facts support the damages awarded, and what standard of proof the panel applied. The Tenth Circuit again disagreed, holding “all that is required is a determination that the award satisfied the requirements for nondischargeability described in § 523(a)(19)."
Behrends also conceded that the Denver County District Court order confirming the award and entering judgment thereon “qualifies as a judicial order memorializing the debt.”
The implications herein are significant, but at this point largely unpublicized. According to a PIABA report, as much as $62.1 million in customer awards issued in 2013 alone were unpaid, and an many as $1 of every $4 awarded is unpaid. https://piaba.org/system/files/pdfs/Unpaid%20Arbitration%20Awards%20-%20A%20Problem%20The%20Industry%20Created%20-%20A%20Problem%20The%20Industry%20Must%20Fix%20(February%2025,%202016).pdf.
To the extent these FINRA arbitration awards are unpaid because the Respondent declared bankruptcy, and the judgment is properly registered, In re Behrends indicates that pursuant to 11 U.S.C. § 523(a)(19), such awards would not be discharged in bankruptcy.