BETH A. BUCHANAN, Bankruptcy Judge.
This matter is before this Court on the Debtor's Motion for Judgment on the Pleadings [Docket Number 10] ("
In his Motion, Defendant-Debtor Steven Edward Schuholz ("
Although a split of authority exists on the issue, this Court agrees with Mr. Schuholz that a debt cannot be held nondischargeable under § 523(a)(19) based on the securities violations of another person. Nonetheless, in this case, the state court judgment includes an explicit determination that Mr. Schuholz, himself, violated Ohio securities laws by receiving money, without having a license, for recruiting investors into Galemmo's Ponzi scheme. Because the pleadings do not establish what portion, if any, of the state court judgment award is attributable to Mr. Schuholz's Ohio securities laws violation, the portion of the debt that may be held nondischargeable pursuant to § 523(a)(19) must be determined through subsequent dispositive motions or trial. With respect to the Plaintiffs' other nondischargeability claims, while the State court did not make specific findings that would establish certain elements required to hold the debt nondischargeable under § 523(a)(2)(A) and § 523(a)(6), the lack of such findings does not preclude this Court from making its own determination of those issues at trial. Accordingly, Mr. Schuholz's Motion is denied.
This Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 157(a) and 1334, and the standing General Order of Reference in this District. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I). The parties have consented to final judgment being rendered by this Court in this adversary proceeding [Docket Number 12].
Plaintiffs filed an Amended Complaint to determine the dischargeability of a state court class-action judgment debt against Mr. Schuholz [Docket Number 4] ("
Mr. Schuholz was a defendant in the Class Action and the matter proceeded to trial against him [Id., ¶ 5]. On July 11, 2017, following a bench trial, the State Court entered final judgment in favor of the Plaintiff Class and against Mr. Schuholz in the amount of $864,534.16 plus interest and costs [Id.].
In the Amended Complaint, the Plaintiffs summarize findings and conclusions from the State Court, but do not provide a copy of the State Court's judgment [Id., ¶¶ 9-22]. However, Mr. Schuholz incorporates and attaches copies of the State Court's Final Judgment Entry and Findings of Fact and Conclusions of Law to his Answer [Docket Number 7, Exs. A and B]. The State Court Judgment Entry and Findings of Fact and Conclusions of Law include almost identical findings and conclusions. Accordingly, this Court lists the findings and conclusions from the State Court Judgment Entry except where stated:
[Docket Number 7, Ex. A].
In their Amended Complaint, the Plaintiffs assert that the State Court judgment debt owed by Mr. Schuholz is for violations of securities laws and is nondischargeable under 11 U.S.C. § 523(a)(19). They further assert that Mr. Schuholz obtained money through material misrepresentations about the Galemmo Ponzi scheme when he spoke with investors, which makes the debt nondischargeable pursuant to 11 U.S.C. § 523(a)(2)(A). Finally, they assert that Mr. Schuholz acted willfully or with substantial certainty to cause injury and maliciously when he participated in the Galemmo Ponzi scheme as a referral source making the debt nondischargeable pursuant to 11 U.S.C. § 523(a)(6).
Mr. Schuholz requests judgment on the pleadings pursuant to Federal Rule of Civil Procedure ("
When deciding a motion for judgment on the pleadings, a court is limited to considering the contents of the pleadings. Raymond Prof'l Group, Inc. v. William A. Pope Co. (In re Raymond Prof'l Group, Inc.), 386 B.R. 678, 681 (Bankr. N.D. Ill. 2008). However, "a court may consider: (1) any documents attached to, incorporated by, or referred to in the pleadings; (2) documents attached to the motion . . . that are referred to in the complaint and are central to the plaintiffs' allegations, even if not explicitly incorporated by reference; (3) public records; and (4) matters of which the court may take judicial notice." Embassy Realty Investments, LLC v. City of Cleveland, 877 F.Supp.2d 564, 570 (N.D. Ohio 2012) (further citation omitted). See also Seaton v. TripAdvisor LLC, 728 F.3d 592, 596 (6th Cir. 2013) (stating that although matters outside the pleadings are not to be considered when ruling on a Rule 12(b)(6) motion to dismiss, documents attached to the motion to dismiss are considered part of the pleadings if they are referred to in the complaint and are central to the plaintiff's claims). In other words, "`[a] defendant may introduce certain pertinent documents if the plaintiff chooses not to do so.'" Embassy Realty, 877 F. Supp. 2d at 570 (further citation omitted). "`Otherwise, a plaintiff with a legally deficient claim could survive a motion to dismiss simply by failing to attach a dispositive document upon which it relied.'" Id.
In the Amended Complaint, the Plaintiffs reference, but do not attach, the State Court's Findings of Fact and Conclusions of Law as well as its Final Judgment Entry. Mr. Schuholz, however, attaches both of these documents to his Answer [Docket Number 7, Exs. A and B]. These critical documents are incorporated into the pleadings and may be considered by this Court in determining Mr. Schuholz's Motion.
Mr. Schuholz calls upon this Court to address the adequacy of the Plaintiffs' claims that the $864,534.16 class-action State Court judgment debt is excepted from discharge under various provisions of 11 U.S.C. § 523(a).
Section 523(a)(19) provides that:
11 U.S.C. § 523(a)(19). This provision is a relatively recent addition to the Bankruptcy Code enacted as part of the Sarbanes-Oxley Act in 2002 "to address perceived loopholes in securities laws after the Enron debacle." Oklahoma Dep't of Sec. v. Wilcox, 691 F.3d 1171, 1175 (10th Cir. 2012). The legislative history reveals Congressional concerns that current bankruptcy laws had permitted "wrongdoers to discharge their obligations under court judgments or settlements based on securities fraud and other securities violations." S. Rep. No. 107-146, 107th Cong., 2nd Sess. 2002, 2002 WL 863249, at *10, 16 (May 6, 2002). Accordingly, § 523(a)(19) was drafted to close this perceived loophole and "help defrauded investors recoup their losses and to hold accountable those who incur debts by violating our securities laws." Id.
Mr. Schuholz asserts that for a debt to be excepted from discharge under § 523(a)(19), the debt must be for a securities violation by the debtor. According to Mr. Schuholz, the State Court determined all of the wrongdoing and securities violations to be on the part of the Ponzi scheme operator, Glen Galemmo, rather than Mr. Schuholz himself. As such, Mr. Schuholz's debt, which he construes as one for unjust enrichment in the form of profits from the Ponzi scheme, cannot be considered a debt for a securities violation because the securities laws were violated by someone other than himself.
Contrary to Mr. Schuholz's argument, a circuit split exists regarding whether a judgment may be excepted from discharge under § 523(a)(19) based on a debt arising from a violation of securities laws by another person. Compare Oklahoma Dep't of Sec. v. Wilcox, 691 F.3d 1171, 1176-77 (10th Cir. 2012) (determining that § 523(a)(19) does not apply to except from discharge a judgment debt for unjust enrichment resulting from a Ponzi scheme when the debtor was not charged with violating securities laws), and Sherman v. Sec. and Exch. Comm'n, 658 F.3d 1009, 1012 (9th Cir. 2011) (similar holding to Wilcox but decision was abrogated on other grounds relating to § 523(a)(4) by Bullock v. BankChampaign, N.A., 569 U.S. 267, 271 (2016)), with Lunsford v. Process Tech. Servs., LLC (In re Lunsford), 848 F.3d 963, 968 (11th Cir. 2017) (holding that the text of § 523(a)(19)(A) "precludes discharge regardless of whether the debtor violated securities laws as long as the securities violation caused the debt").
In Wilcox, the Tenth Circuit considered whether state court judgments based on unjust enrichment requiring debtors to disgorge profits received from their investments in a Ponzi scheme qualified as judgments "for a violation" of securities laws under § 523(a)(19)(A).
Turning to the plain language of § 523(a)(19)(A), the Tenth Circuit determined that a judgment debt against a debtor must be "for a violation" of securities laws in order to be excepted from discharge. Id. The Tenth Circuit concluded that the judgments at issue did not meet this requirement because they were based on a claim of unjust enrichment that resulted from someone else's violation of securities laws. Id. at 1176-77.
To support its determination, the Tenth Circuit reviewed legislative history and, particularly, the Senate Report, to determine the purpose behind the enactment of § 523(a)(19)(A). Id. at 1175-76. The Tenth Circuit cited statements in the Senate Report that the statute was designed to "`help defrauded investors recoup their losses,'" hold "`accountable those who incur debts by violating our securities laws'" and protect victims from "`those who have cheated them.'" Id. (citing S. Rep. No. 107-146 at 8, 11). From the statute's text and the legislative history behind it, the Tenth Circuit concluded that § 523(a)(19) was intended to:
Id. Accordingly, the Tenth Circuit concluded that a judgment debt for unjust enrichment against an innocent investor in someone else's Ponzi scheme, when that investor had not been found to violate securities laws but only profited from someone else's violation, was not a debt excepted from discharge under § 523(a)(19). Id. at 1176-77.
Likewise, in Sherman, the Ninth Circuit considered whether a debt may be excepted from discharge under § 523(a)(19) when the debt resulted from a violation of state or federal securities laws but the debtor himself was not culpable for the violation that caused the debt.
Wilcox and Sherman stand in sharp contrast with the Eleventh Circuit's conclusion in Lunsford that a debt may be excepted from discharge under § 523(a)(19) whether the debt stems from the debtor's own violation of securities laws or a third party's violation. 848 F.3d at 968.
After review of these various interpretations, this Court sides with the Ninth and Tenth Circuits in concluding that § 523(a)(19) excepts from discharge only those debts arising from the debtor's own securities laws violations. First, the Supreme Court and the Sixth Circuit have made clear that § 523(a) provisions should be construed narrowly in favor of discharging debts of an honest debtor. Kawaauhau v. Geiger, 523 U.S. 57, 62 (1998) (concluding that exceptions to discharge "should be confined to those plainly expressed"); Grogan v. Garner, 498 U.S. 279, 286-87 (1991); Meyers v. Internal Revenue Serv. (In re Meyers), 196 F.3d 622, 624 (6th Cir. 1999) (citing Grogan to support that "[a]s a general matter, exceptions to discharge are narrowly construed to promote the central purpose of the discharge: relief for the `honest but unfortunate debtor'"). Based on this principle of narrow construction, § 523(a)(19)(A)'s scope is properly limited to debts for violations arising from the debtor's own misconduct rather than that of a third party. To interpret this statute otherwise, as noted by the Ninth Circuit, would contravene this rule of narrow construction in favor of the opposite presumption, "that exceptions [to discharge] should be applied broadly unless expressly confined to guilty debtors." Sherman, 658 F.3d at 1015.
Second, the Senate Report, cited by both the Ninth and Tenth Circuits, supports this narrow interpretation of § 523(a)(19). The Senate report reveals that Congress intended § 523(a)(19) to "hold accountable those who incur debts by violating our securities laws" and prevent "wrongdoers" from discharging their obligations. S. Rep. No. 107-146 at *11, 16. There is no indication in the Senate Report that Congress intended to render nondischargeable debts of innocent investors who happen to profit from a third-party's scheme. Id. While courts may order investors to disgorge profits remaining in their possession that were received in a Ponzi scheme, this Court agrees with the Ninth Circuit that Congress did not intend to immunize these debts from discharge in bankruptcy when the debtor has not been found guilty of any wrongdoing. Sherman, 658 F.3d at 106.
While this Court agrees with Mr. Schuholz's interpretation of the limited scope of § 523(a)(19), that conclusion does not end the inquiry. This Court must still determine whether the State Court judgment debt, or some part of it, falls within the scope of that provision. Mr. Schuholz argues that the judgment debt falls outside the scope of § 523(a)(19) because only Mr. Galemmo, the Ponzi scheme operator, was found to have violated securities laws by the State Court. Accordingly, Mr. Schuholz likens himself to the "innocent investors" in the Wilcox case who were not found to have violated securities laws themselves and whose debts were based solely on common law unjust enrichment arising from someone else's securities laws violations. See Wilcox, 691 F.3d at 1176-77.
Contrary to Mr. Schuholz's argument, this case is distinguishable from Wilcox. Unlike the "innocent investors" in that case, the State Court found Mr. Schuholz, himself, to have violated Ohio securities laws:
[Docket Number 7, Ex. A (Final Judge Entry), pp. 5, 8]. With these findings, the State Court makes clear that Mr. Schuholz's own conduct of receiving funds or commissions, without an appropriate license, for recruiting investors into Mr. Galemmo's Ponzi scheme violated Ohio securities laws. Accordingly, his situation is distinguishable from the "innocent investors" in Wilcox.
While the State Court found Mr. Schuholz to have violated Ohio securities laws, it is less clear whether its award of damages to the Plaintiff Class, in whole or in part, is attributable to Mr. Schuholz's securities laws violation. Mr. Schuholz argues that, as a matter of law, the damages award could not be "for" a violation of Ohio securities laws because those laws create no civil liability for violations.
In making this argument, Mr. Schuholz refers to Ohio Rev. Code § 1707.40 which provides:
Ohio Rev. Code § 1707.40. Read in conjunction with the civil liability and remedy provisions that follow it, this provision has been interpreted to mean that Ohio securities laws, Ohio Rev. Code § 1707.01-§ 1707.99, do not replace or negate common law claims based on securities violations (except where provided), but do set the parameters for liability and remedies in various ways. For example, Ohio Rev. Code § 1707.41 sets forth civil liability, in addition to other liability imposed by law, that a seller may have to a purchaser for false written materials about securities offered for sale and creates a statute of limitations for such actions. See In re Nat'l Century Fin. Enter., Inc., 504 F.Supp.2d 287, 305-06 (S.D. Ohio 2007) (concluding that Ohio Rev. Code § 1707.41 "imposes liability for misstatements in a `written, or printed circular, prospectus or advertisement.'"). Ohio Rev. Code § 1707.42 sets forth liability and damages of an adviser to a purchaser of securities. See Ohio Bureau of Workers' Comp. v. MDL Active Duration Fund, Ltd., 476 F.Supp.2d 809, 818 (S.D. Ohio 2007) (noting that Ohio Rev. Code § 1707.42(B) "provides that an investment adviser is liable for damages resulting from acts of an investment adviser which violate Ohio Rev. Code Chapter 1707."). Furthermore, Ohio Rev. Code § 1707.43 provides limited remedies that a purchaser may have against a person selling unlawful securities as well as persons participating in the sale or aiding the seller and sets forth a statute of limitations. See Federated Mgmt. Co. v. Coopers & Lybrand, 738 N.E.2d 842, 857 (Ohio Ct. App. 2000) (concluding that § 1707.43 extends liability beyond the actual seller/issuer of an unlawful security to any other person who participated in the sale or aided the seller in any way). Moreover, various courts have concluded that when common law claims are "predicated on or inextricably interwoven with the sale of securities . . .," the applicable statute of limitations is set by the Ohio securities laws. Lopardo v. Lehman Bros., Inc., 548 F.Supp.2d 450, 467 (N.D. Ohio 2008) (citing cases). See also Wuliger v. Anstaett, 363 F.Supp.2d 917, 935 (N.D. Ohio 2005) (applying the § 1707.43 statute of limitations to claims sounding in common law fraud, breach of contract and unjust enrichment when they arise from the sale of securities investments); Helman v. EPL Prolong, Inc., 743 N.E.2d 484, 493 (Ohio Ct. App. 2000) (concluding that the statute of limitation in Ohio Rev. Code § 1707.43 applied to a breach of contract claim involving an unlawful sale of securities).
What is clear from these Ohio statutory provisions and case law is that a person may be held civilly liable to a purchaser or investor for violating Ohio securities laws whether under a common law claim or the "intertwining" of common law and the statutory provisions of Ohio Rev. Code § 1707.01-§ 1707.99.
While rejecting Mr. Schuholz's legal argument, this Court remains unable to determine on the pleadings and the documents incorporated therein whether the judgment debt, or a portion thereof, is "for" Mr. Schuholz's securities laws violation and, thus, excepted from discharge under § 523(a)(19). The language of the State Court's Final Judgment Entry and Findings of Fact and Conclusions of Law fails to specify what portion, if any, of the $864,534.16 in damages awarded to the Plaintiff Class was "for" (or attributable to) Mr. Schuholz's receipt of funds for recruiting investors into the Ponzi scheme without a license, i.e. the conduct found to violate Ohio securities laws.
When the language of a judgment does not reasonably establish whether the damage award is based on a violation of securities laws, a court must look to the context and circumstances under which the award arose to make the determination. Schouten v. Jakubiak (In re Jakubiak), 591 B.R. 364, 375-79 (Bankr. E.D. Wis. 2018). See also Hines v. Aetna Cas. & Sur. Co., 1992 Ohio App. LEXIS 47, at *15, 1992 WL 2588, at *5 (Ohio Ct. App. Jan. 9, 1992) (citing Hofer v. Hofer, 42 N.E.2d 165, 167 (Ohio Ct. App. 1940) and other case law to support that when an Ohio judgment is ambiguous, the entire record may be examined and considered to determine its construction and interpretation). This issue cannot be determined at this stage of the litigation.
Accordingly, this Court concludes that Mr. Schuholz is not entitled to judgment on the pleadings with respect to the Plaintiffs' § 523(a)(19) claim.
Mr. Schuholz further requests judgment on the pleadings with respect to claims that the State Court judgment debt is excepted from discharge under 11 U.S.C. § 523(a)(2)(A) and § 523(a)(6).
Mr. Schuholz further argues that this Court is precluded from relitigating not only those issues actually determined by the State Court, but also issues that could have been decided and that arise out of the same transaction or occurrence. As such, Mr. Schuholz maintains that the Plaintiffs are precluded from asserting claims for securities violations, fraud, and other intentional torts in this adversary proceeding.
This Court recognizes that, pursuant to 28 U.S.C. § 1738, federal courts are directed to give the same "full faith and credit" to a state court judgment as another court of that state would give. Sill v. Sweeney (In re Sweeney), 276 B.R. 186, 189 (B.A.P. 6th Cir. 2002) (citing Markowitz v. Campbell (In re Markowitz), 190 F.3d 455, 461 (6th Cir. 1999)). Consequently, to determine whether the State Court's Final Judgment Entry and Findings of Fact and Conclusions of Law are entitled to preclusive effect in this dischargeability proceeding, this Court must determine whether they would be entitled to such effect under Ohio's preclusionary principles.
Mr. Schuholz raises both issue preclusion and claim preclusion. "Issue preclusion refers to the effect of a judgment in foreclosing relitigation of a matter that has been actually litigated and decided." Corzin v. Fordu (In re Fordu), 201 F.3d 693, 703 (6th Cir. 1999) (citing Migra v. Warren City Sch. Dist. Bd. of Educ., 465 U.S. 75, 77 n.1 (1984)). Under Ohio law, the doctrine of issue preclusion has four elements:
Sweeney, 276 B.R. at 189 (citations omitted).
In comparison, "`[c]laim preclusion generally refers to the effect of a judgment in foreclosing litigation of a matter that never has been litigated, because of a determination that it should have been advanced in an earlier suit.'" In re Fordu, 201 F.3d at 703 (quoting Migra, 465 U.S. at 77 n.1). Under Ohio law, claim preclusion has four elements:
Hapgood v. City of Warren, 127 F.3d 490, 493 (6th Cir. 1997) (citations omitted).
The party seeking to invoke preclusion has the burden to establish its applicability. Simmons Capital Advisors, Ltd. v. Bachinski (In re Bachinski), 393 B.R. 522, 535 (Bankr. S.D. Ohio 2008) (discussing issue preclusion); Winget v. JP Morgan Chase Bank, N.A., 537 F.3d 565, 572 (6th Cir. 2008) (discussing claim preclusion).
Mr. Schuholz correctly notes that the State Court Court's Final Judgment Entry and Findings of Fact and Conclusions of Law lack any determinations that he committed fraudulent acts or a willful and malicious injury to the Plaintiffs. However, for issue preclusion to apply, Mr. Schuholz would further have to establish that these issues were actually litigated by the parties and necessarily determined by the State Court in its judgment. Sweeney, 276 B.R. at 189; Miller v. Grimsley (In re Grimsley), 449 B.R. 602, 609 (Bankr. S.D. Ohio 2011). At this stage, neither the pleadings nor the Final Judgment Entry and Findings of Fact and Conclusions of Law establish that Mr. Schuholz's commission (or non-commission) of fraudulent acts or a willful and malicious injury were actually litigated and necessary to the State Court's judgment.
Mr. Schuholz similarly fails to meet his burden to establish claim preclusion. This Court would first note that it does not appear from the Amended Complaint that the Plaintiffs are asserting claims for new or additional debt owed to them. Rather, they seek a determination that a debt that has already been awarded to them is nondischargeable under § 523(a) of the Bankruptcy Code. To the extent that Mr. Schuholz is asserting that this Court is precluded from considering the Plaintiffs' nondischargeability claims under § 523(a)(2) and (6) of the Bankruptcy Code because those claims arise out of the same transaction or occurrence as the claims asserted in the State Court action, such an assertion is incorrect.
Bruinsma v. Wigger (In re Wigger), 595 B.R. 236, 249 (Bankr. W.D. Mich. 2018) (quotation marks and citations omitted). See also, MD Acquisition, LLC v. Myers (In re Myers), 2012 Bankr. LEXIS 5953, at *16-17, 2012 WL 6761356, at *5 (Bankr. N.D. Ohio, Dec. 31, 2012); In re Hall, 98 B.R. 777, 779 (Bankr. S.D. Ohio 1989).
The State Court case was the Plaintiffs' cause of action on the debt itself and this adversary proceeding is the Plaintiffs' cause of action to determine whether that debt is nondischargeable. Whereas claim preclusion may apply to the existence and amount of the debt, it does not apply to this Court's determination as to whether such debt is nondischargeable. Accordingly, Mr. Schuholz is not entitled to judgment with respect to the Plaintiffs' claims under § 523(a)(2)(A) and (a)(6) of the Bankruptcy Code.
For the reasons stated above, Debtor's Motion for Judgment on the Pleadings [Docket Number 10] is
