In re Scarlata, 90 C 2933.

• Decision Date: 30 May 1991
• Docket Number: No. 90 C 2933.,90 C 2933.
• Citation: 127 BR 1004
• Parties: In re Richard C. SCARLATA, Debtor. GOLDBERG SECURITIES, INC., Plaintiff/Appellee/Cross Appellant, v. Richard C. SCARLATA, Defendant/Appellant/Cross Appellee.
• Court: U.S. District Court — Northern District of Illinois

127 B.R. 1004 (1991)

In re Richard C. SCARLATA, Debtor GOLDBERG SECURITIES, INC., Plaintiff/Appellee/Cross Appellant, v. Richard C. SCARLATA, Defendant/Appellant/Cross Appellee.

No. 90 C 2933.

United States District Court, N.D. Illinois, E.D.

May 30, 1991.

COPYRIGHT MATERIAL OMITTED

Donald Cahill Shine, Neisen & Elliott, Chicago, Ill., for Goldberg Securities, Inc.

Andrew B. David, William J. Gigler, Sugar, Friedberg & Felsenthal, Chicago, Ill., for Richard C. Scarlata.

MEMORANDUM OPINION AND ORDER

LEINENWEBER, District Judge.

This is an appeal and cross-appeal from a bankruptcy court judgment holding that a certain debt was barred from discharge pursuant to 11 U.S.C. § 523(a)(2)(A), and that the same debt was not barred from discharge under 11 U.S.C. § 523(a)(6). See Goldberg Securities, Inc. v. Scarlata (In re Scarlata), 112 B.R. 279 (Bankr.N.D.Ill. 1990). For the reasons stated herein, the judgment of the bankruptcy court is reversed with respect to Section 523(a)(2)(A) but affirmed with respect to Section 523(a)(6).

FACTS

This appeal concerns a certain debt owed by debtor-defendant Richard Scarlata ("Scarlata") to Goldberg Securities, Inc. ("Goldberg") resulting from Scarlata's trading activities on the Chicago Board of Options Exchange ("CBOE") in October 1987. In October 1987, Scarlata was a market-maker specialist trading for his own account on the floor of the CBOE. Scarlata was trading almost exclusively in the stock index option known as the "OEX" option.¹ Goldberg is a clearing member of the CBOE engaged in the business of clearing member accounts and transactions made through accounts at the CBOE. In addition to clearing the accounts of market-makers, clearing firms must also guarantee the trades of all traders clearing though that particular clearing firm to the Options Clearing Corporation ("OCC"). Scarlata began clearing his account through Goldberg in December, 1983, and continued until October 19, 1987. Thus, Goldberg was required to assume full financial responsibility for any trade that Scarlata lacked the financial means to cover during this period.

Scarlata cleared his account through Goldberg without major problems until the end of October 1987. During the week prior to October 16, 1987, the Dow Jones Industrial Average (the "Dow") declined dramatically. On Friday, October 16, 1987, the Dow dropped 108 points. As a result, Scarlata suffered heavy trading losses in his account with Goldberg. By the close of trading on Friday, October 16, 1987, Scarlata had assets of $22,000 of net equity in his trading account at Goldberg, approximately $3,500 in cash accounts and items of personalty of nominal value. Scarlata, 112 B.R. at 284. In addition, at the end of trading on Friday, October 16, 1987, Scarlata had a substantial open short OEX put position of 84 contracts which he knew would continue to erode equity in his trading account if the market continued its decline.² According to Scarlata's testimony at trial, he wanted to be in short puts because he hoped and expected that the market would open higher on Monday, October 19, 1987. Trial Tr. 2-2-90, pp. 135-36.

Clearing firms generally review the accounts of market-makers to scrutinize the amount of net equity in the respective trading accounts relative to the positions of a particular trader. Trial Tr. 1-29-90, pp. 112-118. Consistent with industry standards, Scarlata understood that Goldberg required a ratio of two-to-one or three-to-one of equity relative to positions. Id. at 117. On Monday, October 19, 1987, Scarlata did not have enough equity in his trading account to continue trading under rules established by the Securities Exchange Commission ("SEC") and Goldberg's internal rules.

Thus, on the morning of Monday, October 19, 1987, Scarlata knew that he was likely to be on Goldberg's list of troubled accounts. Trial Tr. 1-31-90, pp. 165, 167. In order to be allowed to trade, Scarlata knew he would be required to increase the equity in his account by making a cash deposit or by reducing the size of his open short put position in OEX contracts. Early in the morning and prior to commencement of trading on Monday, October 19, 1987, Scarlata went into the conference room where Goldberg's risk managers were reviewing trader accounts and gave Goldberg's senior risk manager a check in the amount of $30,000. In addition, Scarlata expressly represented to the risk manager that he intended to reduce his positions. Trial Tr. 2-1-90, pp. 57-61.

At the time Scarlata presented the check for $30,000, he had neither sufficient funds in his checking account nor sufficient assets to cover the check. Scarlata testified that he intended to go to the bank during his break on Monday and deposit money to cover the check. Trial Tr. 2-1-90, p. 159; 2-2-90, pp. 20-21. Scarlata further testified that he arranged with his bank to cover the check, which created an overdraft in his checking account. Trial Tr. 2-1-90, p. 21-22. The next day, October 20, 1987, Scarlata borrowed approximately $29,500 from various credit cards for the purpose of covering the check. The check was honored by Scarlata's bank.

Prior to the opening of trading, Scarlata received reports from oversees markets which indicated that the market would open lower on Monday, October 19, 1987. Trial Tr. 2-1-90, pp. 62-63. The Dow did, in fact, begin steep decline from the opening. Scarlata began to sustain losses in his trading account as a result of his open short put position. Although Scarlata was sustaining losses and did not have the equity in his account to increase his position further, he began to increase the size of his short put position. Apparently, Scarlata hoped and expected that the market would rebound and thus offset the losses in his account. Although the market rebounded slightly, it eventually closed down 508.32 points. By the end of trading on Monday, October 19, 1987, Scarlata had increased his position to the point where he was short 1035 OEX put option contracts. The loss was eventually liquidated at $4,769,091.87.³ Goldberg was required to and did pay the full amount to the OCC.

Scarlata filed his Chapter 7 bankruptcy proceeding on March 7, 1988. Goldberg brought an adversary proceeding on June 13, 1988 seeking to bar dischargeability of the debt under Sections 523(a)(2)(A) and (a)(6). The issues presented on appeal are: (1) whether the bankruptcy court erred in finding that Goldberg met its burden to bar dischargeability of the debt under Section 523(a)(2)(A), (2) whether the bankruptcy court erred by allowing Goldberg's expert witness to hear Scarlata's testimony, (3) whether the bankruptcy court erred by allowing Goldberg to file amended proposed findings of fact and conclusions of law and (4) whether the bankruptcy court erred by refusing to allow testimony as to trading losses sustained by third parties on October 19, 1987. The issue on Goldberg's cross-appeal is whether the bankruptcy court erred by finding that Scarlata's actions did not constitute wilful and malicious injury pursuant to Section 523(a)(6).

DISCUSSION

When a district court reviews a decision of the bankruptcy court, the bankruptcy court's conclusions of law are reviewed de novo. In re Excalibur Automobile Corp., 859 F.2d 454, 457 n. 3 (7th Cir.1988). The district court, however, is required to accept the bankruptcy court's findings of fact unless they are clearly erroneous. See Bankruptcy Rule 8013 (West 1987); see also In re Excalibur Automobile Corp., 859 F.2d 454, 457 n. 3 (7th Cir.1988); In re Kimzey, 761 F.2d 421, 423 (7th Cir.1985). Moreover, the party seeking reversal of the bankruptcy court's findings must show that the findings were clearly erroneous, and not merely that the bankruptcy court could have reached another decision. First Bank of Whiting v. Kham & Nate's Shoes No. 2, Inc., 104 B.R. 909, 910 (N.D.Ill.1989) citing In re Soucek, 50 B.R. 753, 755 (N.D.Ill.1985).⁴ The district court may "disturb the findings of the bankruptcy court only if it is `left with the definite and firm conviction that a mistake has been committed.'" Id. citing Matter of Muller, 851 F.2d 916, 920 (7th Cir.1988).

I. Scarlata's Appeal

A. Count I — 11 U.S.C. § 523(a)(2)(A)

In order to bar dischargeability of the debt under Section 523(a)(2)(A),⁵ Goldberg was required to establish three elements by clear and convincing evidence: (1) that on October 19, 1987, Scarlata obtained continued permission to trade and Goldberg's continued guarantee of his trades through false pretenses or by making representations that were either knowingly false or were made with reckless disregard for the truth as to constitute wilful misrepresentation; (2) that in making the false pretenses and/or false representations, Scarlata possessed an actual intent to defraud Goldberg; and (3) that Goldberg actually and reasonably relied on the false pretenses or false representations. Scarlata, 112 B.R. at 287, citing In re Kimzey, 761 F.2d at 423; In re Iaquinta, 98 B.R. 919, 923 (Bankr.N.D.Ill.1989).

The bankruptcy court found that Goldberg proved by clear and convincing evidence that Scarlata's $30,000 check was a false pretense and that Scarlata "wilfully and falsely misrepresented that he intended to reduce or neutralize his short put position in order to be permitted to trade freely." Scarlata, 112 B.R. at 287. In its factual findings, the bankruptcy court found that Scarlata's statement that he would reduce or neutralize his position was "false at the time it was made and he then knew it was false." Id. at 284, ¶ 22. The court found the statement false because it affirmatively found that "prior to making that promise, Scarlata had over the prior weekend already formulated a plan to increase substantially the size of his existing OEX position in order to take advantage of what he perceived to be an substantial opportunity in the active market." Id.⁶ Thus, the court found that since Scarlata had already formulated a...