Discharge of Judgment Related to Ponzi Scheme

Posted by NCBRC - February 7, 2022

A judgment against the debtor based on fraudulent transfer of funds arising out of his gains in a Ponzi scheme was dischargeable where the court found that only a debt traceable to a securities law violation committed by the debtor is excepted from discharge under section 523(a)(19) and the debtor in this case was not liable for a securities violation. In re Simons, 2021 WL 5225940 (Bankr. D. Minn. Nov. 9, 2021) (case no. 4:20-bk-40631; adv. proc. no. 4:21-ap-4027).

When the debtor filed for chapter 7 bankruptcy he listed Nationwide Judgment Recovery, Inc., as an unsecured judgment creditor. The judgment was based on a finding in district court that the debtor had received funds as a “net winner” in a Ponzi scheme. The Ponzi scheme was the subject of a prior SEC action against Rex Venture Group, LLC (“RVG”) and its principal Paul Burks who ran the scheme through ZeekRewards.com. The debtor was not a principal in the scheme, nor was he a defendant in the SEC action. Pursuant to the SEC judgment, a Temporary Receiver was appointed. He filed a claw back action against the debtor and other net winners under the North Carolina Uniform Fraudulent Transfer Act (“NCUFTA”). In August, 2017, the district court in the claw back action found in favor of the Receiver and entered judgment against the debtor in the amount of $190,959.94, comprising $142,194.29 in net winnings and $48,765.65 in prejudgment interest.

NJR filed an adversary proceeding in the debtor’s chapter 7 bankruptcy, seeking a finding that the funds were excepted from discharge under 523(a)(19) which excepts debts arising from securities violations. The parties filed opposing motions for summary judgment. The bankruptcy court framed the questions as: “First, whether a debt traceable to a securities law violation that was committed by a non-debtor third party falls within the scope of Section 523(a)(19). Second, whether Defendant’s Final Judgment debt is for common law fraud, deceit, or manipulation in connection with the purchase or sale of any security.”

The debtor argued that section 523(a)(19)(A)(i) does not apply because the complaint failed to allege that the debt in question was based on violation by the debtor of securities law. NJR countered that any debt arising out of a violation of Securities Laws is covered by section 523(a)(19) without regard to whether the debtor was personally liable for the violation. NJR urged the court to follow the Eleventh Circuit’s lead in Lunsford v. Process Techs. Servs., LLC (In re Lunsford), 848 F.3d 963 (11th Cir. 2017) where the court found that section 523(a)(19) applies without regard to the debtor’s conduct so long as the debt is created by a securities violation.

The Ninth and Tenth Circuits, on the other hand, reached the contrary conclusion, finding that section 523(a)(19) requires conduct by the debtor in violation of securities laws. Okla. Dep’t of Sec. v. Wilcox (In re Wilcox), 691 F.3d 1171 (10th Cir. 2012); Sherman v. SEC (In re Sherman), 658 F.3d 1009 (9th Cir. 2011), abrogated on other grounds by Bullock v. BankChampaign, N.A., 569 U.S. 267 (2013). Those courts relied in part on Congress’s rejection of language in section 523(a)(19) excepting debts “relating to” securities violations in favor of the language excepting a debt that “is for” securities violation.

The court here was persuaded by the reasoning out of the Ninth and Tenth Circuits and concluded that “that only a debt traceable to a securities law violation committed by a debtor is subject to Section 523(a)(19).” Here, the debtor was ordered to disgorge his winnings, not because he had violated securities law, but because the initial transfer of those winnings to him was fraudulent under the NCUFTA. The court found that because the judgment was not based on the debtor’s violation of securities law, section 523(a)(19)(A)(i) was inapplicable.

NJR next argued that the debt was nondischargeable under section 523(a)(19)(A)(ii), which excepts from discharge debts based on “common law fraud, deceit, or manipulation in connection with the purchase or sale of any security.” However, NJR failed to offer any evidence that the debtor bought or sold securities. Moreover, the judgment order out of the district court did not find that the debtor bought or sold securities or that the underlying fraudulent transfers were in connection with the purchase or sale of securities. The court concluded, therefore, that section 523(a)(19)(A)(ii) was inapplicable.

Finding that neither section 523(a)(19)(A)(i) or (ii) applied, the court granted summary judgment in favor of the debtor.

NJR’s appeal is currently pending before the Bankruptcy Appellate Panel for the Eighth Circuit, Case No. 21-6013.

Simons Bankr D. Minn Nov 2021




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