Sherman v. SEC (In re Sherman)

Case No. 09-55880 (9th Cir. September 19, 2011)
Reversed the district court and held that the exception to discharge under 11 U.S.C. § 523(a)(19) applies only to debtors who have themselves violated the securities laws, and not to persons who are simply found to owe a debt which the SEC is authorized to enforce pursuant to a disgorgement order.
Procedural context:
Debtors sought declaratory relief to establish that a particular debt owed to the SEC had been discharged under 11 U.S.C. § 727. The bankruptcy court granted summary judgment in favor of debtors and concluded, as a matter of law, that the debt at issue was subject to discharge as part of chapter 7 proceedings; the district court reversed and held that the debt was excepted from discharge. The debtors appealed.
Debtor-Appellant, Richard Sherman, is an attorney who represented certain defendants in an SEC enforcement action. The receiver appointed in the enforcement action ordered Sherman to disgorge money he had received and retained, but had not earned, in a contingency case. (The SEC admitted that Sherman himself had not violated any securities laws.) Before the hearing on the disgorgement motion, Sherman and his wife filed for chapter 7 relief. After appeal was taken on separate issues, the bankruptcy court granted the Shermans a discharge under 11 U.S.C. § 727. Subsequently, the Shermans sought declaratory relief to establish that their debt to the SEC had been discharged under § 727 in spite of the discharge exception available under 11 U.S.C. § 523(a)(19). The bankruptcy court determined, as a matter of law, that the SEC's disgorgement order did not arise from Sherman's own violation of the securities laws, reasoning that section 523(a)(19) was meant to apply to wrongdoers and not to persons who happen to owe a debt which the SEC may enforce via a disgorgement order. The SEC appealed to the district court, which reversed the bankruptcy court. The district court interpreted section 523(a)(19) broadly so as not to frustrate the ability of the SEC to enforce the federal securities laws. The Shermans appealed.
Raymond C. Fisher and Jay S. Bybee, Circuit Judges; Lyle E. Strom, Senior District Judge for the U.S. District Court for Omaha, Nebraska (sitting by designation); Opinion by Circuit Judge, Jay S. Bybee

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