Emory Bankruptcy Developments Journal


Holly Baird


In two cases recently decided by the Ninth and Tenth Circuits, the courts independently considered whether a disgorgement order levied by securities regulators against a debtor is excepted from statutory discharge under § 523(a)(19) of the Code. The issue split the panels in both cases, producing vehement dissents. In both circuits, the majority held that § 523 does not except a debt arising from a disgorgement order from statutory discharge under § 727 if the debtor has not been charged with or convicted of violating state or federal securities laws. Thus, a debtor's obligation to disgorge funds acquired through the fraudulent activity of a third party is a dischargeable obligation in bankruptcy. This Comment argues that the decisions by the Ninth and Tenth Circuits incorrectly construed the plain meaning of § 523(a)(19) and ignored language in the statute that broadens the exception to embrace a debtor's obligation to disgorge funds acquired through the fraudulent misconduct of another individual. The Comment emphasizes that the character of the debt determined by the state courts should have been given preclusive effect by the bankruptcy courts. Deference to the state courts coincides with long-standing doctrines in bankruptcy law, which preserve in bankruptcy the property rights of the debtor defined by state or non-bankruptcy law. This new approach would aid the enforcement of security laws and support a framework for debtor attorneys and regulators preparing for litigation. Finally, lending preclusive effect to disgorgement orders does not threaten misappropriation of § 523 exceptions. Properly construed, § 523(a)(19) should except a debtor's obligation to return fraudulent funds regardless of their culpability for a security violation because there is a legitimate government interest in mitigating the egregious effect of large-scale investment fraud and protecting investors.