In 2002, in the wake Worldcom and Enron the United States Congress among other things amended the United States Bankruptcy Code to provide that Bankruptcy Code does not discharge an individual debtor from any debt incurred in connection with 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
Sarbanes Oxley Act of 2002. 11 U.S.C. § 523 (a)(19)(July 2002).
However, on November 6, 2017,Chief Judge Susan V. Kelley of the Federal Bankruptcy Court for the Eastern District of Wisconsin held that a stockbroker whose conduct was “unprofessional and unresponsive” to an investor but not false or fraudulent, can still wipe out their debts in bankruptcy. In re Butler, 2017 BL 398139, Bankr. E.D. Wis., Case No. 17-22141-SVK Adv. No. 17-02169, Nov. 6, 2017.
In Butler, Jeffrey Lane Butler was a stockbroker registered with a number of securities broker-dealers. FINRA Public Disclosure also shows that Butler was also subject to a number of customer complaints over time.
Susan Dorsch was one of Butler’s clients or customers.
According to Dorsch when she agreed to open an account with Butler, she was near retirement age, and explained to Butler that she needed consistent and stable income from her retirement account so that she could live.
In response to Ms. Dorsch’s concernss Butler told her he was developing a “new investment strategy” that would a be a long-term investment, but in fact “day traded” her account, and purchased and sold shares of “aggressive, high-risk stocks” resulting in significant losses.
Ms. Dorsch filed a complaint with the Wisconsin Department of Financial Institutions which ordered, in the absence of a written contract, that Ms. Dorsch’s advisory fees to be refunded.
Thereafter, Ms. Dorsch filed a securities arbitration claim with the Financial Industry Regulatory Authority or FINRA against Butler and immediately thereafter, Butler filed for bankruptcy.
Securities fraud is defined in section 3(a)(47) of the Securities Exchange Act of 1934. To state a claim for securities fraud under § 10 (b), and Rule 10b-5, as promulgated thereunder by the SEC, 17 C.F.R. §240.10b-5, a private plaintiff must plead that defendants knowingly or recklessly made a false representation or omission of a material fact, and that plaintiff’s reliance thereon was the proximate cause of his or her injury. Kline v. First Western Gov’t. Securities, Inc., 24 F.3d 480, 487 (3rd Cir.), cert. denied, 506 U.S. 934 (1994); Shapiro v. UJB Financial Corp., 964 F.2d 272, 280 (3rd Cir.), cert. denied, 506 U.S.934 (1992); Peil v. Speiser, 806 F.2d 1154, 1160 (3rd Cir. 1986).
The sale or recommendation of “unsuitable securities” is a subspecies of fraud by omission.
However, Judge Kelley held that Ms. Dorch’s claim was dischargeable by Butler in bankruptcy despite the provisions of Sarbanes Oxley because “Mr. Butler disclosed the names of those investments” and he “did not steal her money.”
The Court also invoked the familiar mantra, that investing in securities is “risky by nature,” and Butler was not a “guarantor of the return an investor can expect in the stock market.”
Prior to being appointed to the bench, Judge Kelley was she a partner in the Madison, Wisconsin office of Michael, Best & Friedrich. Michael Best, a healthy financial service defense practice and specifically that:
Our Banking and Financial Services practice assists financial firms of all sizes. Clients include regional, national, and global institutions in a variety of sectors, from holding companies to banks, savings banks, savings and loans, credit unions, trust companies, mutual funds, and insurance companies.
Michael H. Schaalman of Halling & Cayo, in Milwaukee, Wisconsin and Paul G. Swanson of Steinhilber Swanson LLP, Oshkosh, Wisconsin represented Susan Dorsch. Jeffrey L. Butler represented himself, and certainly did a great job.
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