In the Matter of John Michael Caples v. Caples

454 B.R. 191

In the Matter of John Michael CAPLES, SSN: XXX–XX–XXXX, Debtor(s).Darrel Nevels, Plaintiff(s),

v.John Michael Caples, Defendant(s).

Bankruptcy No. 10–05230–JAC–7.

Adversary No. 10–80114–JAC–7.

United States Bankruptcy Court, N.D. Alabama, Northern Division.

July 7, 2011.

Lee Wendell Loder, Loder Law Firm, Birmingham, AL, for Plaintiff.Frederick Mott Garfield, Sexton & Associates, PC, Birmingham, AL, for Defendant.

MEMORANDUM OPINION

JACK CADDELL, Bankruptcy Judge.

On June 20, 2011, this matter came before the Court for trial on the complaint to determine dischargeability of debt filed by Darrel Nevels against the debtor pursuant to 11 U.S.C. § 523(a)(2), (4) and (6).¹ For the reasons set forth below, the Court finds that the debt is nondischargeable pursuant to 11 U.S.C. § 523(a)(4).

FINDINGS OF FACT

1. On September 1, 2010, the debtor filed for bankruptcy relief under Chapter 7 of the Bankruptcy Code. Plaintiff timely filed this complaint in which he alleges that the losses he sustained in an OptionsXpress investment account controlled by the debtor were the result of fraud, defalcation while acting in a fiduciary capacity, willful and malicious conversion, or embezzlement.

2. On May 24, 2010, plaintiff obtained a default judgment entered by the Circuit Court of Jefferson County, Alabama against the debtor in the amount of $153,000 based on the funds lost in the OptionsXpress account. On Schedule F–Creditors Holding Unsecured Nonpriority Claims, the debtor listed the $153,000 judgment debt as an unsecured claim.

3. By post-trial stipulation submitted by the parties in this adversary, the parties agree that over a period of time the plaintiff paid the debtor no less than $70,686.14 and no more than $103,000 for investment into the OptionsXpress account maintained by John Caples. The parties further agree that the debtor made payments back to the plaintiff of no less $25,000 and no more than $32,500 with a total net difference between $38,186.14 and $78,000. The Court finds that the evidence at trial supports the high end of this range for a loss of $78,000 resulting from debtor's investment methods involving the plaintiff's funds.

4. The debtor is a highschool graduate. In the Spring of 2006, the debtor ventured into the practice of day trading after he completed an on-line investment program. The debtor is not a registered securities dealer or investment advisor in the State of Alabama.² After the debtor completed the on-line investment program, he opened an OptionsXpress account in which he began day trading on behalf of himself and his mother-in-law, Rita Powell, with an initial investment of $18,000 provided by Powell. OptionsXpress is an on-line brokerage account. The debtor explained that he would research different companies to determine which companies were profitable based on what he learned from an on-line site called Investtools.

5. Powell owns several health food stores in Jefferson County, Alabama. The debtor openly carried out his day trading business at the front counter of one of the health food stores while he made trades in the OptionsXpress account on behalf of himself, Powell, and several other store employees.

6. The plaintiff has a degree in the field of Naturopathy. He obtained his degree from Trinity School of Natural Health and began his practice by renting space from Powell at one of the health food stores. The plaintiff's practice focuses on a client's whole physical and emotional well being using natural herbs and exercise. After the plaintiff obtained his degree in Naturopathy, he initially hired an out-of-state licensed brokerage firm named Rydex to handle his investments. Plaintiff soon became dissatisfied with Rydex because the brokerage firm lost $3,000 in his account and was unable to satisfy certain accounting/tax questions he wanted clarified. The plaintiff explained that he was very concerned about the loss because he was investing for himself, his son and his mother's future. Plaintiff expressed his dissatisfaction with the brokerage firm to Powell who is also an accountant. Powell encouraged the plaintiff to seek the debtor's investment advice. Plaintiff alleges that Powell told him that the debtor was a really good broker and that he had several clients at the store. It is apparent from the plaintiff's testimony that he placed complete trust in Powell, and still highly regards her, as he refers to her as “Elder Mother.” Plaintiff referred to both the debtor and Powell as family.

7. At some point in 2006, Powell introduced the plaintiff to the debtor and suggested that the debtor help the plaintiff with his investment needs. After they were introduced, the plaintiff and debtor discussed the debtor's day trading business. The debtor explained that he had just finished school but had gained experience by investing for Powell's health food stores. The plaintiff alleges that the debtor told him that he had a “certificate” to trade stocks, that he was a better broker than Rydex, and that he was an online trader. The debtor denies acting as a financial planner or advisor for plaintiff, but admits that he took the plaintiff's money and agreed to invest same for the plaintiff. The debtor admits that he used his OptionsXpress account to make trades for the plaintiff, himself, Powell, and other health food store employees.

8. On July 7, 2007, the debtor and plaintiff both signed a handwritten agreement stating that the debtor agreed to invest $20,000 for the plaintiff for an initial period of six months. Over the next two years, the debtor acted as the plaintiff's investment advisor and broker. During this time period, the plaintiff would occasionally ask the debtor to stop making trades when the market was down, but the plaintiff otherwise relied upon and allowed the debtor to make all other investment decisions and trades.

9. The plaintiff testified that he understood the debtor would either create a separate account for the plaintiff's investments or that the debtor would put his dividends into a separate account on behalf of the debtor. Instead, the debtor took the funds and co-mingled the funds into the OptionsXpress account that was owned jointly by himself and Powell.

10. The debtor did not charge the plaintiff for his investment services, but enjoyed the use of and complete control over the debtor's funds as capital in his personal day trading account. The debtor testified that his goal was to provide for “everyone's” retirement.

11. On October 28, 2009, the plaintiff told the debtor to stop trading and asked for a return of his money. Plaintiff alleges that there was $95,654 in the account in October of 2009, but the debtor asserts that there was actually only $9,500 in the account. By February or March of 2010, the debtor admits that he had lost all but $24 in the account. The plaintiff testified that he asked for his money to be returned on several occasions during this time period, but he never pressed the matter in part because he thought of the debtor as family. The debtor admitted that the plaintiff told him that he wanted to get out of the market in the fall of 2009, but the debtor asserts that the money was tied up and could not be immediately liquidated.

12. The debtor testified that he invested and lost $7,500 of his own money, $28,000 of Powell's money, plus all of the plaintiff's money. The debtor asserts that he lost the money as a result of general market conditions.

CONCLUSIONS OF LAW

Based upon the forgoing, the plaintiff seeks a determination that the debt arising from the debtor's day trading losses is excepted from discharge pursuant to § 523(a)(4) on the ground that the debtor committed an act of defalcation while acting in a fiduciary capacity. The debtor argues that there is no evidence of a fiduciary relationship to support a claim under § 523(a)(4). The Court disagrees.

Section 523(a)(4) of the Bankruptcy Code excludes from discharge any debt “for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” 11 U.S.C. § 523(a)(4). To sustain a cause of action under this section for defalcation, the plaintiff must establish two elements: (1) that the debtor was acting in a fiduciary capacity; and (2) committed an act of defalcation while acting in such capacity.³ The plaintiff must prove each element by a preponderance of the evidence.⁴

Although the Bankruptcy Code does not define the term “fiduciary capacity” for purposes of § 523(a)(4), federal case law narrowly construes same.⁵ Federal law provides that the traditional definition of fiduciary is not applicable in bankruptcy. “The traditional meaning of fiduciary under state law—loyalty, good faith and fair dealing—is too broad for purposes of this section.” ⁶ Instead, federal courts have “articulated a requirement that the trust relationship have existed prior to the act which created the debt in order to fall within the statutory

[fiduciary

capacity] exception.” ⁷ “Involuntary trusts such as constructive or resulting trusts do not satisfy § 523(a)(4) because the act which created the debt simultaneously created the trust relationship.” ⁸ “It is not enough that by the very act of wrongdoing out of which the contested debt arose, the bankrupt has become chargeable as a trustee ex maleficio. He must have been a trustee before the wrong and without reference thereto.” ⁹ Thus, § 523(a)(4) only applies to “a person who was already a fiduciary when the debt was created.” ¹⁰ Fiduciary trusts relationships that are implied in law as a remedy for some dereliction of duty are not excepted from discharge.¹¹

Rather, federal case law limits the § 523(a)(4) exception to situations involving express or technical trusts. ¹² Express trusts are voluntary trusts created by contract.¹³ An express trust must generally be in writing and must express the parties intent to create a trust, specifically define the trust property, and name both a beneficiary and ...