In the Matter of Andrea P. Sherman v. Sec.

• Decision Date: 19 September 2011
• Docket Number: No. 09–55880.,09–55880.
• Citation: 55 Bankr.Ct.Dec. 124,2011 Daily Journal D.A.R. 14223,11 Cal. Daily Op. Serv. 11954,658 F.3d 1009
• Parties: In the Matter of Andrea P. SHERMAN; Richard G. Sherman, Debtors.Richard G. Sherman, Appellant,v.Securities and Exchange Commission, Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

658 F.3d 1009

55 Bankr.Ct.Dec. 124

11 Cal. Daily Op. Serv. 11,954

2011 Daily Journal D.A.R. 14,223

In the Matter of Andrea P. SHERMAN; Richard G. Sherman, Debtors.Richard G. Sherman, Appellant,

v.Securities and Exchange Commission, Appellee.

No. 09–55880.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Oct. 7, 2010.Filed Sept. 19, 2011.

M. Jonathan Hayes, Law Offices of M. Jonathan Hayes, Northridge, CA, for the appellant.Hope Hall Augustini, Senior Litigation Counsel, Securities and Exchange Commission, for the appellee.Appeal from the United States District Court for the Central District of California, Christina A. Snyder, District Judge, Presiding. D.C. No. 2:08–cv–02517–CAS.

Before: RAYMOND C. FISHER and JAY S. BYBEE, Circuit Judges, and LYLE E. STROM, Senior District Judge.^*Opinion by Judge BYBEE; Dissent by Judge FISHER.

OPINION

BYBEE, Circuit Judge:

Ordinarily, an individual's debts may be discharged in Chapter 7 bankruptcy under 11 U.S.C. § 727. However, a debt may not be discharged if it results from a violation of state or federal securities laws. 11 U.S.C. § 523(a)(19)(A)(i). The question in this case is whether the exception to discharge in § 523(a)(19) ¹ applies when the debtor himself is not culpable for the securities violation that caused the debt. The bankruptcy court held that the debt was subject to discharge; the district court disagreed and held that the debt was excepted from discharge in bankruptcy. We agree with the bankruptcy court that the exception to discharge applies only to those who have themselves violated the securities laws. We thus reverse the judgment of the district court.

I

We have previously described the facts in this case, which we will relate briefly. See In re Sherman (“ Sherman I ”), 491 F.3d 948, 953–56 (9th Cir.2007). In 1997, the SEC instituted an enforcement action against several companies, which, among other things, led to the court appointment of a receiver.² See id. at 953–54 & n. 3 (citing SEC v. Whitworth Energy Res. Ltd., 243 F.3d 549 (9th Cir.2000) (unpublished table decision)). Debtor–Appellant Richard Sherman is an attorney who represented some of the defendants in this enforcement action. Id. at 954.

As part of the enforcement action, the receiver ordered Sherman to disgorge two separate sums of money. Id. First, he was ordered to disgorge $54,980 that he withdrew from his clients' litigation trust account in violation of a freeze order issued by the district court. Id. This debt is not at issue in this case. Second, the receiver ordered Sherman to return money he had received and retained, but had not earned, in a separate contingency case. Id. at 954–55. The district court calculated that he was responsible for disgorging $581,313.43 plus interest. The court held that Sherman lacked any interest in the money because he was obligated by the California Rules of Professional Conduct to return the amount by which his advances exceeded his ultimate fee. Importantly for our purposes, the SEC conceded that Sherman had not been found to have committed any securities violations on his own. See id. at 974 n. 33 (“[T]he present case involves a debtor who was not found to have himself violated the securities laws and has not been alleged to have committed other acts of fraud by the SEC.”).

Four days before the hearing on the disgorgement motion, Sherman and his wife filed a petition for Chapter 7 bankruptcy. Id. at 954. The SEC and the receiver responded by filing a motion to dismiss the petition. Id. at 955. The receiver independently filed a motion seeking a determination by the court that Sherman's debts arising from the disgorgement order should be held nondischargeable under § 523(a)(4) and (6) ³ of the Bankruptcy Code. Id. The bankruptcy court denied the motion, and the SEC appealed to the district court, which reversed. Id. at 955–56. While the appeal was pending, the bankruptcy court granted Sherman a discharge under 11 U.S.C. § 727. Id. at 955. In Sherman I, we addressed a number of standing-related questions ⁴ and held that Sherman's conduct did not constitute “cause” sufficient to warrant dismissal under § 707(a) of the Code, which allows a bankruptcy court to dismiss petitions filed in bad faith. Id. at 975. We then mentioned that “the SEC could have filed—and still could file—a complaint under § 523(a)(7) or (19),” though we did not explicitly conclude whether the SEC would prevail under either provision.⁵ Id. at 975 n. 39.

In a subsequent adversary proceeding, the Shermans sought declaratory relief to establish that their debt to the SEC had been discharged under § 727 notwithstanding § 523(a)(19)'s discharge exception. The bankruptcy court granted summary judgment for the Shermans. It concluded, as a matter of law, that the SEC's disgorgement order did not arise from a violation of securities laws. It further ruled that “[s]ection 523(a)(19) was intended to apply to ‘wrongdoers' and not to persons who are simply found to owe a debt which the SEC is authorized to enforce.”

The SEC appealed to the district court, which reversed the bankruptcy court. The district court adopted a broad interpretation of § 523(a)(19), treating as paramount the Sarbanes–Oxley Act's goal of “protect[ing] investors by improving accuracy and reliability of corporate disclosures made pursuant to the securities laws.” It expressed particular concern that “[r]eading a limitation into the SEC's ability to enforce its powers to obtain disgorgement of ill-gotten funds in an appropriate case ... would frustrate the ability of the SEC to enforce the federal securities laws.” Sherman appeals.⁶

II

We begin by making it clear that, in this case, the validity of the disgorgement order against Sherman is not at issue. We have previously held that a so-called “nominal defendant” may be ordered to disgorge funds that are traceable to fraud. See SEC v. Colello, 139 F.3d 674, 676 (9th Cir.1998) ( “[A]mple authority supports the proposition that the broad equitable powers of the federal courts can be employed to recover ill gotten gains for the benefit of the victims of wrongdoing, whether held by the original wrongdoer or by one who has received the proceeds after the wrong.”). The courts can order the disgorgement of proceeds of fraud held by “nominal defendants” because they “ ‘hold[ ] the subject matter of the litigation in a subordinate or possessory capacity as to which there is no dispute.’ ” Id. at 676 (quoting SEC v. Cherif, 933 F.2d 403, 414 (7th Cir.1991)). A nominal defendant is “not a real party in interest because ‘he has no legitimate claim to the disputed property.’ ” SEC v. Ross, 504 F.3d 1130, 1141 (9th Cir.2007) (quoting Colello, 139 F.3d at 676).⁷ We found that Sherman “was effectively acting as a depository for those funds, as he legitimately obtained them in the first place but no longer had a valid claim to retain them,” and thus could be ordered to disgorge “money ... retained in excess of his fee for the services rendered in the contingency suits.” Sherman I, 491 F.3d at 959.

The only question at issue here is whether Sherman's debt resulting from the disgorgement order can be discharged under § 727 of the Bankruptcy Code (“Code”), or whether it falls under the exception to discharge created by § 523(a)(19). The Code provides, in relevant part, that “[a] discharge under § 727 ... does not discharge an individual from any debt,” § 523(a), that is for

(i) the violation of any of the Federal securities laws (as that term is defined in section 3(a)(47) of the Securities Exchange Act of 1934), 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

...

11 U.S.C. § 523(a)(19)(A). The bankruptcy court, siding with Sherman, held that a debt cannot be “for” a securities violation when the debtor has not committed such a violation. The district court, siding with the government, held that § 523(a)(19) is not limited to “persons who have been accused or found guilty of violations of the securities laws.” Although the question is a close one, we agree with the bankruptcy court and hold that § 523(a)(19) only prevents the discharge of a debt for a securities violation when the debtor is responsible for that violation.

A

We begin with the statute. The question is whether a debt can be “for” one of the violations listed in § 523(a)(19)(A) when the debtor has not committed any of those violations. The dictionary definition of the word “for” does not give us a clear answer. The word “for” is capacious, meaning, among other things, “[a]s the price of, or the penalty on account of”; “[i]n requital of”; or “[i]n order to obtain”; and “[i]n consequence of, by reason of, as the effect of.” VI Oxford English Dictionary 24–26 (2d ed.1989), available at http:// www. oed. com/ view/ Entry/ 72761. On the one hand, in some sense, Sherman's debt was “the penalty on account of” the securities violations committed by his clients. On the other hand, we cannot say that Sherman owes the debt “in requital of” fraudulent conduct—Sherman's debt results from the fact that he never “earned” the money he owes, and not because he committed any wrongdoing.

The plain language of the statute alone does not clearly resolve the interpretive question before us. But it does bring into focus the interpretive dilemma in reading § 523(a)(19)(A): Should that section be read as if it said that a debt shall not be discharged if it “is for the violation by the debtor of any of the Federal securities laws”? Or, should the section be read as if it said that a debt shall not be discharged if it “is for the violation by the debtor or anyone else of the Federal securities laws”?

The government encourages us to focus on the absence of any explicit textual indication that the underlying violation must be committed by the...