In re Scheuer
| Decision Date | 29 March 1991 |
| Docket Number | Adv. No. SA 90-0390 JR.,Bankruptcy No. SA 90-00355 JR |
| Citation | 125 BR 584 |
| Court | U.S. Bankruptcy Court — Central District of California |
| Parties | In re Danny Jay SCHEUER, Debtor. Abraham LOCK, Plaintiff, v. Danny Jay SCHEUER, Defendant. |
Michael A. Bertz, Los Angeles, Cal., for plaintiff.
Donald Segretti, Newport Beach, Cal., for defendant.
Plaintiff obtained default judgment against debtor in the Central District Court of California in the amount of $118,962.82, plus a surcharge for violations of RICO in the amount of $237,925.64, plus attorney's fees of $17,500 (the "Judgment"). Plaintiff alleged in his district court complaint violations of the Commodity Exchange Act, breaches of fiduciary duties, common law fraud, and violations of the RICO Act. Judgment was joint and several against debtor, Modoc Trading Corporation ("Modoc") and F.G. Hunter & Associates ("Hunter"). On January 18, 1990, debtor filed a voluntary petition under Chapter 7. At the time of the filing, he had made no payments on the Judgment. Plaintiff timely filed a complaint for nondischargeability regarding the Judgment based upon § 523(a)(2)(A) and § 523(a)(4) of the Bankruptcy Code (the "Complaint"). After a two-day trial, I took the matter under submission primarily to decide the questions (1) whether debtor is a "fiduciary" subject to § 523(a)(4) and (2) whether the punitive element of the Judgment should be held nondischargeable.
This court has jurisdiction over this adversary proceeding pursuant to 28 U.S.C. § 1334(a) (), 28 U.S.C. § 157(a) () and General Order No. 266, dated October 9, 1984 (referring all Title 11 cases and proceedings to the bankruptcy judges for the Central District of California). This matter is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I).
Plaintiff is a medical doctor residing in Brooklyn, New York. Around April 27, 1983, he read a Modoc advertisement in USA Today that read in part "SILVER — $10,000 WORTH OF SILVER FOR ONLY $1,500?" The advertisement went on to say (the "Modoc Program"). At the time, plaintiff had invested in silver valued at $47,000 (the "Silver") and was looking for an adviser for additional investments.
After contacting Modoc, he received calls from Mr. Gallagher and Mr. Lama who represented Modoc. Plaintiff explained to Gallagher and Lama that he had no experience in commodity futures or commodity future markets, that he had no desire to invest in futures, as he heard they were risky, and that his sole investment experience involved a mutual fund and the Silver. Plaintiff was told by Gallagher and Lama that the Modoc Program did not involve commodity futures or the futures market and that it was safer than investing in futures. They also said that they would guide him in his investment decisions each step of the way. Furthermore, they urged him to sell the Silver and reinvest the proceeds with Modoc.
Plaintiff asked Gallagher and Lama if Modoc was accredited, and he was told that it was. He was also given references. Plaintiff was encouraged to follow the recommendations of Gallagher and Lama. A week later plaintiff received a "welcome letter", "references sheet", brochure and a business card from "Al Gallagher" "Account Consultant of Modoc." Shortly thereafter, plaintiff invested $57,545.82, which included proceeds from the liquidation of the Silver.
In late May, based on the advice of Gallagher and Lama, plaintiff invested an additional $25,618.30, the proceeds of which came from the liquidation of his mutual fund holdings and savings. Shortly thereafter, he received a margin call from Modoc. On calling Gallagher and Lama, he was told that he had to protect his investment by sending additional funds to purchase more silver in order to reduce the average price of the silver he held, otherwise his total investment would be lost. He was given no other alternatives. Again, plaintiff followed the advice of Gallagher and Lama and sent an additional $35,798.70, representing borrowed funds and custodial funds that he held for his children.
Later, on August 11, 1983, while attending a medical convention in Miami, he received a call from Gallagher and Lama urging him to sell his silver short. Although initially opposed to the idea, plaintiff acquiesced, based on the arguments of Gallagher and Lama that he was about to lose everything, and he had no other choice. By this time, plaintiff was uncomfortable with what was happening. On August 15, 1983 he, therefore, lodged a complaint with Lama.
Shortly thereafter, he received a call from debtor. Debtor introduced himself as the President of Modoc and told him that he had reviewed plaintiff's transactions. According to plaintiff, debtor criticized the short sale and Gallagher's buying and selling activities. Debtor suggested a liquidation of plaintiff's position and recommended he adopt a new investment strategy. He also indicated that plaintiff had been charged enough commissions and offered to forego charging commissions until he made up his losses.
Feeling somewhat better after talking to debtor, plaintiff left his investment with Modoc. Plaintiff was later introduced to Mr. Wilson, whom Lama stated would replace Gallagher on his account. On November 2, 1983, based on the recommendation of debtor and Wilson, plaintiff transferred the remaining $14,024.13 in his account to Hunter, a successor to Modoc. Through a series of purported transactions, Hunter dissipated plaintiff's remaining assets by December 1983.
Debtor testified that he had authorized the USA Today advertisement and it was designed to get people to call. If a person showed some interest, he was sent "junk" which included a welcome letter, signed by him as "Dan J. Shire" "President," customer agreement, brochure, and reference sheet. He stated that Modoc made its income from commissions on sales to customers like plaintiff and the spread between the retail and wholesale prices for the commodity (the "Spread"). He hired several sales persons to solicit customers and service customer accounts. He asserted that Modoc was not engaged in futures and was not required to register with the Commodity Futures Trading Commission. Debtor further stated that he instructed all sales persons to explain to a prospective investor the investment risks and determine the investor's suitability for the investment and ability to sustain any losses. Furthermore, all orders were confirmed with the client within 24 hours.
Debtor's recollection of the August 1983 telephone call differed from plaintiff's testimony. According to debtor, he informed plaintiff that he had sustained enough of a loss and that he should trade elsewhere. He also told plaintiff that he would make an adjustment to the account regarding commissions. The last four trades on plaintiff's account were made without charges for commissions. Debtor did not remember any other conversation with plaintiff.
Debtor purchased Hunter, because most of his customers wanted to speculate and did not want to take delivery of the precious metals. Since Hunter was licensed, it was able to satisfy this demand for futures contracts.
Debtor testified that he advised his account executives not to "churn"1 accounts. When asked if he had established standards to control "churning" of accounts, he stated that he had not. Rather, he relied on the acknowledgement of order, confirmation of transfers, and the lack of complaints to provide some protection. Supervision of customer accounts was limited to this reliance.
Mr. Edward Horwitz, a licensed registered representative and registered options principal employed by Bateman Eichler, Hill Richards, Inc. with 20 years of experience in the securities and commodities industry, reviewed plaintiff's transactions with Modoc and Hunter and concluded that there was excessive trading in plaintiff's accounts for the purpose of obtaining commissions and other income. He based his conclusion on many factors. These included the large number of in-and-out transactions in the same commodity, same-day transactions, excessive commissions charges (2% on the entire contract)2, and short holding periods (an average of 13 days). Furthermore, on August 11, 1983 there was a short sale of no benefit to plaintiff of 13,000 ounces of silver when the account had silver long, which could have easily been sold without a commission charge.3 There was also an extremely high proportion of commission charges to invested dollars; an extremely high transaction turnover rate;4 and substantial gains for Modoc and Hunter at plaintiff's expense. Horwitz noted the conflict between plaintiff's background objectives and the investments in the Modoc Program. Lastly, he pointed out the high level of control Modoc personnel exercised over plaintiff's account, whereby plaintiff received little financial benefit, while Modoc and its personnel received considerable benefit through commissions and the Spread.
As for references provided by debtor to potential customers, plaintiff showed that debtor had listed two law firms who evidently had done prior legal work for Modoc, but had not given permission to use their firms as references.
Plaintiff asserts that the judgment should be found nondischargeable based on § 523(a)(2)(A) of the Bankruptcy Code. This section excepts from discharge any debt "for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by — (A) false pretenses, a false representation, or actual fraud, other than a statement...
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