Opinion
BANKRUPTCY No. 1-00-04556, ADVERSARY No. 1-01-00030A.
January 13, 2004
Jonathan H. Rudd, Esquire, for the Plaintiff.
Robert C. Rayman, Esquire, for the Respondent.
OPINION
Before me is an adversary proceeding under 11 U.S.C. § 523(a)(2), to render a debt non-dischargeable. The fraud alleged is that the Debtor placed an order with the Plaintiff stock brokerage for 2000 shares of stock and represented he had the ability and the intent to pay for these shares when in fact he did not. The brokerage was forced to sell the shares and absorb the loss, which it wants to reclaim as damages. The instant adversary would render such damages non-dischargeable.
PROCEDURAL HISTORY
On October 16, 2000, Joshua D. Kelso ("Debtor") filed a Chapter 7 bankruptcy petition. By far, his largest unsecured creditor was Merrill Lynch, Pierce, Fenner Smith, Inc. ("Merrill Lynch"), which held a claim of $129,680.00. This claim stemmed from an order which Merrill Lynch had placed for the Debtor to purchase some $259,000.00 worth of Priceline.com, Inc. stock.
On January 31, 2001, Merrill Lynch filed the instant adversary under 11 U.S.C. § 523(a)(2)(A) seeking a declaration that its debt was non-dischargeable due to fraud. After an answer was filed, the case was submitted for decision on the depositions and exhibits. Briefs have been filed and the matter is ripe.
This Court has jurisdiction pursuant to 28 U.S.C. § 157 and 1334. This matter is core pursuant to 28 U.S.C. § 157(b)(2)(I).
FACTUAL FINDINGS
Prior to graduation from Pennsylvania State University, Debtor purchased a condominium in State College, Pennsylvania, for approximately $65,000.00. In 1996, Debtor graduated with a degree in management. He then took a job with MBNA America as a telesales section manager in State College at an annual salary of approximately $29,800.00.
In 1997, Debtor opened an E-Trade Online Brokerage Account with a $500.00 deposit. He bought and held a few stocks but ultimately liquidated the account to pay other bills.
In 1998, Debtor opened an account with Merrill Lynch. This account was known as a "Cash Management Account" or "CMA". The CMA format allowed Debtor to deposit funds into a money market account and to write checks, make VISA purchases and buy stocks against the balance in the account.
Christopher Byrd ("Byrd") was the financial consultant who handled Debtor's account. Byrd's office was in Houston, Texas. Debtor never met Byrd in person. Byrd became Debtor's consultant merely because he was the on-duty consultant who answered the phone on the day Debtor called the Houston office to establish the account. The explanation as to why he chose to deal with the Houston office instead of one geographically closer to him was unclear.
During their first phone conversation, Byrd had Debtor provide him with certain personal financial information, which Byrd recorded in handwriting on a form provided for the purpose. In answering Byrd's questions, Debtor stated that he had $50,000.00 to $75,000.00 in assets available to him to invest. In fact, his assets were de minimis in value. Debtor told Byrd that his annual salary was between $50,000.00 and $75,000.00. Actually, it was $30,000.00. Debtor told Byrd his net worth was between $150,000.00 and $175,000.00. In fact, his debts exceeded his income, and he therefore had no net worth.
Byrd and Debtor spoke frequently — at least a few times a week — during the period in which Debtor traded equities through Merrill Lynch. During these phone calls, they would usually discuss market trends in the technology sector and specific stocks that Debtor might want to buy. These companies traded in the "over-the-counter" market.
"Over-the-counter securities" are securities not listed on one of the national exchanges. See Opper v. Hancock Securities Corp., 250 F.Supp. 668, 671 (S.D.N.Y. 1966); Robinson v. Difford, 92 F.Supp. 145, 147 (E.D. Pa. 1950). An "over-the-counter" market differs from "auction markets", like the New York (NYSE) and American Stock Exchanges (AMEX). See Newton v. Merrill Lynch, Pierce, Fenner Smith, Inc., 259 F.3d 154, 169 (3d. Cir. 2001). The NYSE and AMEX markets have physical exchange floors where buy and sell orders actually "meet". Id. In a dealer market, "the market exists electronically, in the form of a communications system which constantly receives and reports the prices at which geographically dispersed market makers are willing to buy and sell different securities. These market makers compete with one another to buy and sell the same securities using the electronic system." Id.
For over-the-counter stock, Byrd could instantaneously place an order and have it filled while speaking on the phone with Debtor. To ensure accuracy, it was Merrill Lynch's policy to have its account representatives, while placing an order, repeat back to the client the name of the company, the number of shares and the price per share.
Since orders were filled at the punch of a key on a keyboard, such policy would have been imperative to discourage clients from later reneging on a purchase gone sour. Accordingly, as the order was being placed into the account representative's computer, the monitor would generate a screen that would ask a question such as, "was the number of shares repeated back to the customer?"
When a buyer places a telephone order for an over-the-counter stock, the brokerage firm purchases the stock immediately. Under market rules, the buyer then has three (3) days in which to "settle" the transaction; that is, he must provide the brokerage with sufficient assets with which to cover the purchase price. One-time extensions of up to seven days may be obtained under special circumstances. If the buyer neither pays for the stock within the three days nor requests an extension, the brokerage may liquidate the account.
A buyer may also use funds borrowed from his brokerage to buy stock. The buyer will then pay the brokerage interest on the loan. This is called buying "on margin". A buyer may purchase a stock on margin only if he has made specific arrangements to establish a "margin account". Generally, market rules and practices allow a buyer to buy on margin only up to the value of the assets in his account. If the value of the account diminishes to an amount less than the value of the stocks held on margin, the brokerage can compel the buyer to make up the difference in cash. If the difference is not made up, the brokerage can liquidate all or part of the account sufficient to make up the difference. A margin purchase must be specifically authorized by the buyer. Without the client's expressed knowledge and consent, an account representative cannot place a stock purchase order on margin.
Debtor funded his account with a cash deposit of $16,000.00 in March, 1998. This was the only cash deposit Debtor made. Between March and May, 1999, Debtor wrote checks against his CMA account totaling nearly $7,000.00.
On or about May 24, 1999, Debtor is alleged to have ordered 2000 shares of Priceline at $128.93 per share. On this date, Debtor did not have sufficient funds in his account to cover this purchase, either outright or on margin. Byrd would have been required to follow the previously described procedure in placing Debtor's orders. Byrd placed the disputed order while Debtor was still on the phone.
Priceline's stock dropped in value to some $88.00 per share. On June 4, 1999, Merrill Lynch liquidated Debtor's Priceline holdings along with his 500 shares of JB Holdings, his 200 shares of Amazon, and his 200 shares of Microsoft because Debtor failed to pay for the purchase of the 2000 shares of Priceline. Merrill Lynch suffered a loss of $129,680.00 as a result.
DISCUSSION
The Bankruptcy Code section on which Merrill Lynch relies to have the $129,680.00 declared non-dischargeable provides, in pertinent part, that "[a] discharge under § 727 . . . does not discharge an individual debtor for any debt . . . for money . . . to the extent obtained by . . . false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's . . . financial condition." 11 U.S.C. § 523(a)(2)(A).
In all proceedings under § 523(a), the burden is on the creditor to prove by a preponderance of the evidence all elements necessary to the cause of action. See Grogan v. Garner, 498 U.S. 279, 290-91 (1991); Insurance Co. of N. Am. v. Cohn (In re Cohn), 54 F.3d 1108, 1114 (3d Cir. 1995). This burden requires the Court be persuaded that the existence of the facts alleged are more probable than their nonexistence. See Metropolitan Stevedore Co. v. Rambo, 521 U.S. 121, 137 n. 9 (1997); see also Buchholz v. Dewey (In re Dewey), 263 B.R. 258, 263 (Bankr. N.D. Iowa 2001).
In the instant case, Merrill Lynch contends that when Debtor ordered 2000 shares of Priceline, he represented he had the ability to pay for those shares from his own assets (i.e., assets other than potential profits from the stock he was purchasing), and an intent to pay for those shares. Merrill Lynch also contends that Debtor knew this representation and promise were false when he made them. Merrill Lynch avers that it justifiably relied on those representations and, as a result, it suffered losses.
Initially, I note that in a previous unrelated case, I had the opportunity to examine whether use of a credit card constituted a misrepresentation of a debtor's ability to pay and whether such could support that debt's nondischargeability. In re Homschek, 216 B.R. 748 (Bankr. M.D.Pa. 1998). In that case I concluded it would be quite ridiculous for a negligent misrepresentation of that ability to pay, to be categorized as nondischargeable. It was my observation that debtors typically "should have known better" before incurring most debt and, therefore, the obligations of the average debtor are generally a reflection of the debtor's misjudgement of their ability to pay. In re Scocozzo, 220 B.R. 850 (Bankr. M.D.Pa. 1998). This type of negligent miscalculation is clearly not identified as an exception to discharge in 11 U.S.C. § 523.
On the other hand, should the misrepresentation of one's ability to pay be intentional, it is quite apparent that such representation would be of no account unless it be in writing, since false representations "respecting [a] debtor's . . . financial condition" must necessarily be in writing to support a nondischargeability complaint. The Debtor, having submitted no written statement, cannot be held accountable in this regard.Bellco First Fed. Credit Union v. Kaspar (In re Kaspar), 125 F.3d 1358, 1361 (10th Cir. 1997), (Computer-generated form produced from debtors' oral statements in answering questions to complete line of credit and credit card application over telephone did not satisfy "in writing" requirement of discharge exception for false statements of financial condition.)
Alternatively, the placing of a purchase order for goods and services carries the implied representation that the party placing the order intends to pay the obligation according to the agreed upon terms. See, e.g., Cornwell Quality Tools v. Rodgers (In re Rodgers), 115 B.R. 678, 683-84 (Bankr. C.D.Cal. 1990). Whether the party placing the order was unable to pay the obligation at that moment, is, at best, a factor in discovering whether there existed an intent to pay. See Sears v. Homschek (In re Homschek), 216 B.R. 748, 753 (Bankr. M.D.Pa. 1998). Because a misrepresentation of an intent to pay may be difficult to establish, courts have reviewed the totality of the circumstances. See Homschek, 216 B.R. at 753 (citingCitibank (South Dakota) N.A. v. Eashai (In re Eashai), 87 F.3d 1082, 1087 (9th Cir. 1996) and Bank One Columbus, N.A. v. McDonald (In re McDonald), 177 B.R. 212, 216 (Bankr. E.D.Pa. 1994)), First Serv. Corp. v. Schlickmann (In re Schlickmann), 6 B.R. 281, 282 (Bankr. D.Mass. 1980). The pivotal question is, "Did the Debtor intend to pay for the stock when he placed the order with Merrill Lynch?"
Debtor asserts that he never ordered 2000 shares of Priceline, but only 200. He maintains that he did not even know that 2000 shares had been ordered until two weeks after he spoke to Byrd to place the disputed order. He claims that Merrill Lynch is responsible for the negligence of its own agent in placing this order. More generally, Debtor denied having a basic understanding of stock trading. He presented himself as a neophyte investor whose goal was to make long term gains. He portrayed himself as one who was either duped by an unscrupulous broker for unexplained reasons or who was the unfortunate victim of a huge mistake.
To determine the relative merits of each party's case, I will first consider the representations at issue.
"[A] representation of the maker's own intention to do or not to do a particular thing is fraudulent if he does not have that intention." Scocozzo, 220 B.R. at 853 (citing Restatement (Second) of Torts § 530(1) (1976)); see also Meat Requirements Coordination, Inc. v. Salett (In re Salett), 53 B.R. 925, 928 (Bankr. D.Mass. 1985). In Scocozzo, I noted that:
In Field v. Mans, 516 U.S. 59, 116 S.Ct. 437, 133 L.Ed.2d 351 (1995), the Supreme Court observed that terminology utilized in 11 U.S.C. § 523(a)(2)(A) incorporates the "general common law of torts." Id., 516 U.S. at 71 n. 9, 116 S.Ct. at 444 n. 9. Furthermore, "the most widely accepted distillation of the common law of torts [is] the Restatement (Second) of Torts (1976)." Id., 516 U.S. at 70, 116 S.Ct. at 443-444. That "distillation" can be found in Section 525 of the Restatement, Liability for Fraudulent Misrepresentation, which incorporates the following elements established by the historical development of the common law in causes of action in deceit:
1. A false representation made by the defendant. In the ordinary case, this representation must be one of fact.
2. Knowledge or belief on the part of the defendant that the representation is false — or, what is regarded as equivalent, that he has not a sufficient basis of information to make it. This element often is given the technical name of "scienter."
3. An intention to induce the plaintiff to act or to refrain from action in reliance upon the misrepresentation.
4. Justifiable reliance upon the representation on the part of the plaintiff, in taking action or refraining from it.
5. Damage to the plaintiff, resulting from such reliance. William L. Prosser, Handbook of the Law of Torts § 100 (3rd ed. 1964).
Scocozzo, 220 B.R. at 852.
Between October 10, 1998 and June 4, 1999, Debtor bought and sold numerous equities, including Amazon.com, Inc., J.B.Oxford Holdings, Inc., Microsoft Corp., Priceline.com, Inc., Dell Computer Corp., Intel Corp., Lycos, Inc., MBNA Corp, Pepsi Bottling Group, Inc., Flashnet Communications, and Infinity Broadcasting. He bought these equities in excessive quantities relative to his modest income. All told, Debtor purchased some $500,000.00 worth of stocks on his account in eight months time. Debtor made numerous "day trades" without having sufficient funds in his account to pay for them. His very first trade through Merrill Lynch was a "day trade" in which he purchased stock at a cost of over $6,000.00 and sold it the same day at a $900.00 profit. He executed three (3) "day trades" in the six weeks between March 17, 1999 and May 7, 1999. He held none of his remaining stock purchases for more than a few weeks.
Day-traders have been defined as those "who exclusively buy and sell stock rapidly throughout the day trying to make money on short-term market moves." See Hearing on Day Trading Before the Senate Permanent Subcomm. on Investigations, 106th Cong., 1999 WL 27594584 (Sept. 16, 1999) (testimony of Arthur Levitt, Chairman, United States Securities and Exchange Commission); see also McCoun v. Rea (In re Rea), 245 B.R. 77, 81 (Bankr. N.D. Tex. 2000).
On December 10, 1998, Debtor bought 300 shares of Infinity Broadcasting at $20.50 per share. He sold these shares later that same day for $23.56 per share, for a net profit of some $700.00., On March 17, 1999, he bought 100 shares of Lycos at $101.87 per share and fifty more shares the next day for $97.75 per share. He sold all 150 shares on April 22, 1999 for $105.00 per share or some $400.00 profit. Also on March 17, 1999, Debtor bought 150 shares of Flashnet at $41.25 per share. He sold them the very next day at $37.12 per share for a loss of some $850.00. On March 22, 1999, Debtor bought 250 shares of Dell at $37.50 per share. He sold these on May 3, 1999, at $41.12 per share for a profit of some $500.00. On March 30 of 1999, he bought 25 shares of Priceline's initial public offering at $16.00 per share and sold it the same day for $75.37 per share, for a net profit of some $1,400.00. On March 31, 1999, Debtor bought 800 shares of Pepsi at $23.00 per share and sold them the same day for a net loss of $100. Kelso Exhibit 14. On each of the following occasions, Debtor purchased equities without having sufficient funds in his account to pay for them, without later depositing sufficient funds to cover the purchase, and without having a specific margin-purchasing arrangement with Merrill Lynch.
All profit/loss figures are rounded because the record does not show the amount of brokerage fees that Merrill Lynch charged Debtor.
Debtor did not have sufficient funds in his account to pay for this purchase, and he did not have margin privileges at the time. Because Debtor bought and sold this stock on the same day and at a profit, Merrill Lynch did not exercise its right to compel him to provide funds to cover the entire purchase.
1. April 13, 1999: Debtor bought 200 shares of Intel for $60.56 and sold them on May 3, 1999 for $62.31.
2. April 15, 1999: Debtor bought 500 shares of JB Holdings at $19.00 per share.
3. April 23, 1999: Debtor bought 200 shares of Microsoft at $86.25 per share.
4. May 3, 1999: Debtor bought 200 shares of Amazon for $155.50 per share.
5. May 7, 1999: Debtor bought 1000 shares of Priceline at $134.00 per share and sold them the same day at $138.00 per share, for a gross profit of $4,000.00. On this date, Debtor did not have sufficient funds in his account to cover this purchase, whether it was made outright or on margin.
Kelso Exhibit 14.
These facts demonstrate that Debtor's intent in opening the account was to attempt to make quick profits on small movements in a stock's position.
This intent is in keeping with his representations to Byrd, as recorded on the personal financial information sheet, that his investment objective was "growth" and "income" and that his risk factor was "aggressive".
The conclusion becomes inescapable ____ Debtor covered obligations when the stock that he purchased went up. Like the gambler at the card table — he never counted on losing. The pivotal issue of whether the Debtor intended to pay for the stock when he ordered it, be it 200 or 2000 shares, must be decided in Debtor's favor. This is true despite the fact that he had not the wherewithal to pay for the stock should it sink, as it did.
I perceive virtually no distinction between this scenario and that of the gambler in Scocozzo, supra. While the decision to invest was unsupportable, I find the Debtor had every intention of paying his obligations, had he the money, since that is what he did during his entire relationship with Merrill Lynch. On the other hand, had Merrill Lynch been serious about relying on Debtor's financial strength, they would have obtained written verification of same. They are far from blameless in incurring this significant loss.
Since I find that there was no misrepresentation that could support nondischargeability under Section 523(a)(2)(A), I must decide this case against the Plaintiff.
An Order will follow.
ORDER
For those reasons indicated in the Opinion filed this dated, IT IS HEREBY ORDERED that judgment is entered in favor of the Defendant and against the Plaintiff.