In re Scarlata, Bankruptcy No. 88 B 3568
| Decision Date | 30 March 1990 |
| Docket Number | Bankruptcy No. 88 B 3568,Adv. No. 88 A 457. |
| Citation | 112 BR 279 |
| Court | U.S. Bankruptcy Court — Northern District of Illinois |
| Parties | In re Richard C. SCARLATA, Debtor. GOLDBERG SECURITIES, INC., Plaintiff, v. Richard C. SCARLATA, Defendant. |
COPYRIGHT MATERIAL OMITTED
Michael H. Moirano, Nisen & Elliott, Chicago, Ill., for plaintiff.
Jay A. Canel, Peter M. King, Chicago, Ill., for debtor-defendant.
FINDINGS OF FACT AND CONCLUSIONS OF LAW
This action came on for trial before the Court and the issues having been duly tried, the parties rested and final argument was heard. The Court hereby makes and enters the following Findings of Fact and Conclusions of Law:1
FINDINGS OF FACT
3. Goldberg was a clearing member of the Chicago Board of Options Exchange ("CBOE") at all times mentioned in these Findings. As such, Goldberg was engaged in the business of clearing member accounts and clearing stock and index options transactions made in and through such accounts at the CBOE.
4. On December 12, 1983, JR Enterprises (Richard Scarlata nominee), entered into an account agreement with Goldberg pursuant to the terms of which Goldberg agreed to clear transactions in accounts owned by JR Enterprises.
5. JR Enterprises was a partnership comprised of John Bisoulis and Richard Scarlata.
6. One of the accounts opened by JR Enterprises was an account known as Box 3700. This account was traded exclusively by Scarlata and cleared by Goldberg from December, 1983 up through and including October 19, 1987.
7. During the term of JR Enterprises account agreement with Goldberg, with Scarlata's knowledge Goldberg acted as guarantor of Scarlata's personal account, and as such Goldberg was responsible to the Options Clearing Corporation for any debts incurred by Scarlata which Scarlata could not cover.
8. Pursuant to the JR Enterprises account agreement with Goldberg and as a trader in the index options markets at the CBOE, Scarlata cleared his accounts through Goldberg during the period 1984 through 1987, including October 19, 1987, the principal date in issue. His account with Goldberg was liquidated shortly after that date.
9. Following final liquidation of his accounts with Goldberg in 1987, Scarlata owed Goldberg $4,769,091.87. This adversary proceeding was brought to bar dischargeability of that debt under 11 U.S.C. § 523(a)(2)(A) in Count I and 11 U.S.C. § 523(a)(6) in Count II.
10. Scarlata started his career as a professional trader following his graduation from college in 1975, with financial resources provided by his family. He continued with his education and received his M.B.A. from the University of Chicago in 1977. While at the University of Chicago he held two internships; one of which was with Becker Securities. At Becker Securities he worked as a runner on the floor of the CBOE in the spring of 1976. After he received his M.B.A. he worked for Bankers Trust in New York City as an apprentice trader in their money market division. A few months later he returned to Chicago and applied for membership at the CBOE in April/May 1978. Before he began trading on the floor of the CBOE he opened an options trading account at Paine Webber. He became licensed as a broker/dealer with the Securities Exchange Commission, and purchased his CBOE membership for $66,000 in July, 1978.
11. (a) Prior to trading, Scarlata took courses, attended classes and was tested with respect to the capital relationships between the Options Clearing Corp. ("OCC"), the clearing firm and the market maker (trader). As he knew, the clearing firm is required to submit a letter of guarantee to the OCC for traders who carry and clear their options trading account with that firm. Scarlata understood that the OCC accumulated all trades made on a daily basis at the CBOE, that it matched up those trades and provided each clearing firm with accountings of money required to be paid to or collected from the OCC with respect to that trading and the positions taken in the market by traders clearing through each of the respective member firms. He further understood that the clearing firms provided a dual function with respect to traders: an account function whereby they would document their traders' daily trading activity; and the guarantee function, whereby the clearing firm guarantees the trades of all traders clearing their trades through that particular clearing firm. The clearing company does not share in a trader's profit, even though it guarantees his loss. Therefore the trader's representations of trading strategy plans are of critical importance to the clearing company.
(b) Scarlata also knew that a letter of guarantee was given by his clearing firm to the OCC whereby the clearing firm assumed full financial responsibility for trades executed by Scarlata to the extent that he did not have sufficient capital to cover his own capital needs. He also knew if he carried a position in the market overnight that had a "haircut requirement" (an obligation to have funds in his account, more fully explained in Finding No. 26) greater than his account equity balance, then before he could trade again he would need to arrange with his clearing firm's risk manager as to how he intended to deal with that position.
(c) All the foregoing ultimately became part of the agreement and relationship of Scarlata and Goldberg.
12. Scarlata sold his first membership after only a few months. Thereafter he held jobs where he performed a variety of clearing duties and learned various trading strategies. In 1978 he resumed his career as a professional options trader and leased a membership through First Options Corp. ("First Options").
13. In August of 1981 Scarlata's trading activity resulted in a deficit in the amount of $25,000. First Options gave Scarlata an opportunity to pay off the debit by becoming a firm trader. That is, he received a percentage of the profits from trading with funds belonging to First Options. However, in November 1982 Scarlata incurred another deficit through option trading. He became indebted to First Options in the amount of $425,000, which First Options then paid to the OCC pursuant to its letter of guarantee. Notwithstanding his acknowledgement of that debt, Scarlata never repaid any money to First Options in spite of his income in excess of $100,000 in each of the next four years.
14. With funds raised from the sale of his home, Scarlata arranged to resume his professional trading career through Goldberg in 1983. On December 12, 1983, JR Enterprises (Richard Scarlata nominee), entered into an account agreement with Goldberg and opened the account known as Box 3700.
15. The Box 3700 account was traded exclusively by Scarlata, and it was carried and cleared by Goldberg from December, 1983, up through and including October, 1987. During this period, Scarlata traded almost exclusively in the CBOE S & P 100 stock index option known as the "OEX" options.
16. Scarlata traded through Goldberg without problems of significance from December, 1983 until October 19, 1987. Whenever there was a problem with his account he took care of it. He knew when he had to deposit more funds into his account or liquidate or otherwise deal with his positions in the market. Goldberg provided him with an office and other services. Scarlata's relationship with Goldberg was based upon mutual understanding and trust from day to day.
17. Scarlata's pre-October trading activity in 1987 is best summarized by him in his November 15, 1987 letter to Goldberg where he states, "After a poor start in 1987, I went back to the basics of spreading and scalping to earn over $75,000 in August and nearly $100,000 in September." Basically he went from a year-to-date loss of $2,000 at the end of July to a year-to-date profit of $130,000 at the beginning of October, 1987.
18. During the week prior to October 19, 1987, however, the Dow Jones Industrial Average ("DJIA") declined substantially, leading to a severe decline in the value of the OEX stock index. The DJIA declined 108 points on Friday, October 16, 1987. As a result, during that week, Scarlata sustained heavy trading losses in his account at Goldberg. Those losses wiped out a substantial portion of trading gains he had realized earlier that year. By the close of trading on Friday, October 16, 1987, Scarlata had as assets only $22,000.00 in net equity in his trading account at Goldberg, approximately $3,500.00 in cash accounts, and various items of personal property having nominal value. In addition, Scarlata had a substantial open short put position in the OEX index, which he knew would further erode the equity in his account if the DJIA continued its decline.
19. On the morning of October 19, 1987, Scarlata did not have sufficient net equity in his account to continue trading under rules established by the Securities and Exchange Commission ("SEC"), and also established by Goldberg pursuant to their agreement. In order to continue trading, Scarlata knew he would have to increase substantially his net equity by making a significant cash deposit and also by reducing the size of his open position in the OEX index.
20. Scarlata did not wait to be confronted about his situation. In the early morning prior to commencement of trading on October 19, 1987, in order to induce Goldberg to allow him to continue trading, he went in to see and presented to Goldberg's risk manager a check in the amount of $30,000.00 to be applied to his account. Under those circumstances, that check represented an assurance of adequate liquidity in his account to the...
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