Tripodi v. Capital Concepts et al

Filing 136

MEMORANDUM DECISION and Order Re: Nondischargeability and Judgment on the Pleadings- granting 124 Motion Order of Nondischargeability Against Defendant Nathan Welch ; denying 126 Motion for Judgment on the Pleadings ; denying 126 Motion ; denying 126 Motion to Set Aside. Signed by Judge Clark Waddoups on 6/30/14. (jmr)

IN THE UNITED STATES DISTRICT COURT
DISTRICT OF UTAH, CENTRAL DIVISION

ROBERT C. TRIPODI, JR. an individual and
citizen of California
Plaintiff,
v.
CAPITAL CONCEPTS, LLC, a Utah limited
liability company; BLAIR S. ARNELL, an
individual and citizen of Utah; NATHAN
ARNELL, an individual and citizen of Utah;
PRIME WEST JORDANELLE, LLC, a Utah
limited liability company; PWJ HOLDINGS,
a Utah limited liability company; NATHAN
WELCH, an individual and citizen of Utah;
OIL WELL PROPERIES, LLC, a Utah
limited liability company; and JOHN DOES
I-X.
Defendants.

MEMORANDUM DECISION
AND ORDER
RE: NONDISCHARGEABILITY
AND JUDGMENT ON THE
PLEADINGS

Case No. 2:09-CV-00071-CW
Judge Clark Waddoups

INTRODUCTION
Plaintiff Robert C. Tripodi, Jr. moved for an Order of Nondischargeablilty under
18 U.S.C. § 523(a)(19) against Defendant Nathan Welch on the default judgment entered
against him for violating federal and state securities laws.1 Welch opposed the motion
and moved for reconsideration of the order denying his motion to set aside the entry of
default, alternatively for an order setting aside the default judgment, and for judgment on
the pleadings dismissing the claims.2 Upon the completion of briefing the court heard
oral argument on the motions and, from the bench, denied the motions to set aside entry

1

Dkt. No. 124.

2

Dkt. No. 126.

of default, but reserved ruling on the motion for an order of nondischargeability and for
judgment on the pleadings.3 Based on the oral argument, the court reserved ruling on the
question of whether Tripodi had successfully pled that the notes at issue were securities.
Upon further review of the pleadings, the arguments of the parties and the governing
authorities, the court concludes that Tripodi has adequately pled a claim for state and
federal securities violations and Welch’s motion for failure to state a claim is denied.
The court further concludes that the judgment for a securities violation is not
dischargeable under 18 U.S.C. § 523(a)(19) and grants Tripodi’s motion for an order of
nondischargeability.
FACTUAL BACKGROUND
In the course of developing the Talisman real estate project, Prime West
Jordanelle, through Nathan Welch and other defendants, solicited funds from private
lenders to assist in financing the project.4 Welch was primarily responsible for securing
debt financing for the project.5 He pursued a strategy of seeking investment funds from
private investors for use as seed money which he hoped to be able to ultimately
consolidate with one or two large institutional lenders.6
A third party referred Tripodi to the Arnell Defendants7 and told him that they
might have high-yielding investment opportunities that would “mesh” with Tripodi’s

3

Dkt. No. 135.

4

Dkt. No. 1, at 4.

5

Dkt. No. 126, at iv.

6

Id.

7

The Arnell Defendants are defined in the Complaint as Capital Concepts, Blair S. Arnell and Nathan
Arnell. Dkt. No. 1, ¶ 5.

2

retirement plans.8 In early October 2006, Tripodi contacted the Arnell Defendants.9 The
Arnell Defendants then proceeded to solicit funds from Tripodi in “highly endorsed”
opportunities which are the loans evidenced by the Promissory Notes at issue10 and
secured by the Deeds of Trust.11 Tripodi eventually invested a total of one million
dollars.12 The investment was structured as the purchase and assignment of three
Promissory Notes secured by Deeds of Trust and personally guaranteed by Welch. The
transaction was completed in three phases.
First, on December 11, 2006, Welch, as the manager of Prime West Jordanelle,
executed a Deed of Trust and Assignment of Rents in favor of Capital Concepts as
beneficiary to secure an initial principal sum of two million dollars (the “First Deed of
Trust”). Second, four days later, on December 15, 2006, Welch, as the manager of Prime
West Jordanelle signed a Promissory Note promising to pay the face amount of $300,000
on December 15, 2007 to Capital Concepts (the “First Promissory Note”). The First
Promissory Note was secured by the First Deed of Trust. On the same date, Capital
Concepts sold and assigned the First Promissory Note to Tripodi for a payment of
$300,000.13
Third, on January 11, 2007, Welch, as the manager of Prime West Jordanelle,
signed another Promissory Note promising to pay the face amount of $400,000, due

8

Id. at 10.

9

Dkt. No 1, at 11.

10

Id.

11

Dkt. No. 1, at 4-9.

12

Id.

13

Dkt. No. 45, ¶ 20 and attached Ex. 3.

3

within 12 months, to Capital Concepts (the “Second Promissory Note”). The Second
Promissory Note was also secured by the First Deed of Trust. In addition, on the same
day, Welch, again as the manager of Prime West Jordanelle, signed a third Promissory
Note promising to pay the face amount of $300,000, due within 12 months, to Capital
Concepts (the “Third Promissory Note”). The Third Promissory Note was secured by a
second Deed of Trust and Assignment of Rents (the “Second Deed of Trust”) executed
the same day by Welch as the manager of Prime West Jordanelle. On that same date,
Capital Concepts sold and assigned the Second and Third Promissory Notes to Tripodi
for payments totaling $700,000.14
Both Deeds of Trust recited that they would secure multiple promissory notes, not
to exceed the principal sum of $9,125,000, which may be executed simultaneously and
subsequently. Both Deeds of Trust encumbered the identical real property.15 Both Deeds
of Trust gave all secured notes equal lien priority, regardless of the execution date of each
note.16 All three Notes provided that the simple interest on the principal balance would
be paid at the rate of 18% per annum and that in the event of default, the interest would
accrue at a rate of 24% per annum until paid in full.17 Welch personally guaranteed each
of the three Promissory Notes.18 Tripodi did not revise or negotiate the terms and

14

Dkt. No. 45, ¶¶ 29, 43 and attached Exs. 5 and 8.

15

Dkt. No. 1, at 8-9.

16

Dkt. No. 45-2, and Dkt. No. 45-4.

17

Dkt. No. 1, at 6-10.

18

Id.

4

conditions for either Deed of Trust.19 Capital Concepts, and not Nathan Welch, handled
this aspect.20
ANALYSIS
Determining if a Note Is a Security
Welch argues, correctly, that a default judgment cannot be entered if the
complaint fails to state a cause of action.21 His argument, however, that judgment on the
pleadings should be entered in his favor because the Notes Tripodi purchased are not
securities fails. By statute a security is defined as “any note.” 15 U.S.C. § 77b(1).
Nevertheless, notes that bear a “family resemblance” to a category of exceptions through
four articulated factors are not considered to be securities.22 Whether a note is a security
is a question of law23 and, on motion for judgment on the pleadings, the court must draw
all reasonable inferences in Welch’s favor.24

Applying these standards25 and, on

application and balance of the factors articulated in Reves, the court finds that the factors
weigh in favor of characterizing the Notes Tripodi purchased as securities.
The Reves analysis begins with the rebuttable presumption that a note is a
security, unless it bears a strong resemblance to one of the categories of instruments
identified by the Second Circuit in the case of Exchange Nat'l Bank of Chicago v. Touche

19

Dkt. No. 1, at 6-10.

20

Dkt. No. 1, at 19-20.

21

See, e.g., Soren v. Equable Ascent Fin., LLC, 2012 U.S. Dist. LEXIS 84355 at *10 (D. Utah June 15,
2012); Wantz v. Experian Info. Solutions, 386 f.3d 829, 834 (7th Cir. 2004).

22
23

24

Reves v. Ernst & Young, 494 U.S. 56 (1990).
S.E.C. v. Thompson, 732 F.3d 1151, 1161 (10th Cir. 2013).
Id. at 1162.

25

In applying the factors the court considers the pleadings and the subsequent evidence the court required
before entering judgment against Welch.

5

Ross & Co., 544 F.2d 1126, 1137-38 (2d Cir. 1976).26 These categories include a note
delivered in consumer financing, a note secured by a mortgage on a home, a short-term
note secured by a lien on a small business or some of its assets, a note evidencing a
“character” loan to a bank customer, a short-term note secured by an assignment of
accounts receivable, or a note which simply formalizes an open-account debt incurred in
the ordinary course of business.27 The Tripodi Notes do not fall within any of these
types.
If notes do not fall within a recognized exception, as in this case, the court must
consider whether the notes bear a “family resemblance” to instruments that have been
recognized to be non-securities. If a strong resemblance is not found, the court then must
decide whether a new category should be added to the list on exceptions.28
In Reves, the Supreme Court devised a four factor test in determining whether the
“family resemblance” of the note renders it a security.29 These are factors and not
elements that must each be met. They are intended as points of comparison which the
court is to consider in applying a balancing test to determine whether the notes bear a
“family resemblance” to those instruments on the list of exceptions.30
The four factors are: (1) the motivations of the buyer and seller for entering into
the transaction; (2) the distribution plan for the instrument; (3) the reasonable

26

Reves, 494 U.S. at 65-66, 110 S. Ct at 951.

27

Id.

28

Carlucci v. Han, 886 F. Supp. 2d 497, 513 (E.D. Va. 2012) (citing Reves, 494 U.S. at 67, 110 S. Ct.
945).

29

Reves, 494 U.S. at 66, 110 S. Ct. 951.

30

Fox v. Dream Trust, 743 F. Supp. 2d 389, 399 (D.N.J. 2010); See Robyn Meredith, Inc. v. Levy, 440 F.
Supp. 2d 378, 384 (D.N.J. 2006).

6

expectations of the investing public; and (4) whether some factor exists that reduces the
risk of the instrument.31 In the present case, all factors weigh in favor of characterizing
the notes at issue as securities.
1.

Motivations of Buyer and Seller
Under this factor, the court examines the transaction to assess the motivations that

would prompt a reasonable buyer and seller to enter into it. If the seller’s interest is to
raise money for general use of a business enterprise, or to finance substantial
investments, and the buyer is interested primarily in the profit the note is expected to
generate, then the character of the note tends toward it being a security.32 By contrast, if
the note is exchanged to facilitate the purchase and sale of a minor asset or consumer
good, to correct for cash flow problems, or to advance some other commercial or
consumer purpose, the character of the note tends toward it not being a security.33
The purpose for the loan, as understood by the holder of the note, may inform as
to the financial motivations for entering into the transaction. “The inquiry is whether the
motivations are investment (suggesting a security) or commercial or consumer
(suggesting a non-security).”34 This analysis includes consideration of the interest rate to
be paid, a favorable rate indicating that profit was the primary goal of the lender.35 In
Pollack, the investors obtained the notes through their investment advisors as part of an
investment portfolio. They were looking to invest in secure, conservative instruments.

31

Reves, 494 U.S. at 66, 110 S. Ct. 951.

32

Id.

33

Id.

34

Pollack v. Laidlaw Holdings, Inc., 27 F.3d 808, 812 (2d Cir. 1994).

35

Stoiber v. S.E.C., 161 F.3d 745, 750 (D.C. Cir. 1998).

7

That court found that most of the instruments that those investors would take positions in,
such as investment grade commercial bonds, would have a fixed rate of return. The
Second Circuit held that a fixed rate of return in that situation supported a presumption
that the notes were securities.36
In S.E.C. v. Thompson, the court found that the record “contain[ed] substantial
evidence that the holders understood that [the company] was investing their money, and
not “correct[ing] for [its] cash-flow difficulties, or . . . advanc[ing] some other
commercial or consumer purpose.”37 In that case, the prospective holders were motivated
to participate after the defendant told them of the returns he was making, and so they
loaned funds to his company. The investors were promised monthly returns of between
three and five percent on the money they “loaned” the company.38 The court held that
the motivation factor supported a finding that the notes were securities because the
attractive interest rate provided strong evidence that holders were “interested primarily in
the profit the note [was] expected to generate.”39
In this case, the motivation factor evident from the complaint tips in favor of the
notes being securities. Tripodi was directed towards defendants because they may have
high-yielding investment opportunities that would “mesh” with Tripodi’s retirement
plans.40 The Promissory Notes provided interest ranging from 18% to 24%.41 These facts

36

Pollack, 27 F.3d at 813.

37

S.E.C. v. Thompson, 732 F.3d 1151, 1163 (10th Cir. 2013).

38

Id.

39

Id. at 1162.

40

Dkt. No. 1, at 10.
Dkt. No. 1, at 6-10.

41

8

support a conclusion that Tripodi was motivated by investment reasons, not commercial
lending ones.
The court is also required to consider the motivations of the seller. If the seller’s
primary purpose was to raise money for general business use, then that factor also weighs
in favor of a note being a security.42 Conversely, a short-term commercial loan used to
remedy a cash-flow problem would weigh in favor of a note being a non-security.43 In
this case, the motivations of defendants in soliciting funds, as alleged in the complaint,
are somewhat ambiguous. Tripodi alleges that defendants made misrepresentations in
connection with the sale of the notes “to induce broad investment in Prime West
Jordanelle through Capital Concepts.”44 The alleged misrepresentations involve, among
others, statements about the projected success of the project, the high demand for the lots
and the projected value the developed lots were expected to have.45

The

misrepresentations support that defendants were encouraging investments in notes the
repayment of which would depend on the success of the project. These allegations all
weigh in favor of the Tripodi Notes being securities.
Welch argues in his cross-motion that the purpose of the loan was to serve as a
“bridge loan” to address short-term cash flow difficulties.46 But Welch also asserts the
ultimate goal was to “create enough balance sheet liquidity to attract long-term

42

Thompson, 732 F.3d at 1162.

43

Fox v. Dream Trust, 743 F. Supp. 2d at 397-98 (citing Banco Espanol de Credito v. Security Pacific Nat.
Bank, 973 F.2d 51 (2d Cir.1992) (“It is well-settled that certificates evidencing loans by commercial banks
to their customers for use in the customers' current operations are not securities.”)).

44

Dkt. No. 1, ¶ 137.

45

Dkt. No. 1, ¶¶ 61.a through x.

46

Dkt. No. 126, at 19.

9

funding.”47 These assertions, however, can carry no weight in the analysis. Welch
defaulted and is barred from contesting the allegations of the complaint and from
presenting additional evidence in support of his defense.48 Moreover, the assertion at
best allows an inference that the defendants were motivated by both general business
purposes as well as short-term cash flow problems. This factor would not weigh so
strongly in Welch’s favor as to preclude the Notes from being securities.
On balance, the motivation factor weighs in favor of the Promissory Notes being
securities. Investment opportunities through lucrative interest rates motivated Tripodi to
engage in the transaction. Although Welch attempts to provide competing rationales for
the motivation to solicit the Notes, he is barred by his default from asserting such facts
and offering evidence to support them. The “motivation” factor favors Reves’
presumption that the Notes are securities.
2.

Plan of Distribution
The second Reves factor requires that the court analyze the plan of distribution of

the notes at issue to determine whether they are instruments in which “there is common
trading for speculation or investment.”49

The important factors are the size of the

distribution, the sophistication of those taking part, and the negotiation process.
A large quantity of holders is not required to establish common trading for
speculation or investment. Even a small number of holders is not dispositive in
determining that a note is not a security, as a debt instrument may be distributed to but

47

Id.

48

See, e.g. Olcott v. Del. Flood Co., 327 F.3d 1115, 1125 (10th Cir. 2003) (“Defendant by his default,
admits the plaintiff's well-pleaded allegations of fact, is precluded from challenging those facts by the
judgment, and is barred from contesting on appeal the facts thus established.”) (quoting Jackson v. FIE
Corp,, 302 F.3d 515, 525 (5th Cir. 2002)).

49

McNabb v. S.E.C., 298 F.3d 1126, 1132 (9th Cir. 2002) (quoting Reves, 494 U.S. at 66, 110 S. Ct. 951).

10

one investor, yet still be a security.50 For example, in McNabb, the court noted that six
customers in total did not constitute “a broad segment of the public.”51 Yet, when
weighed with the fourth factor where unsophisticated buyers need the protection of
federal securities laws, the lack of broad distribution was not dispositive.52
If notes are sold to a broad segment of the public, then “common trading” is
established.53 But it is not required that the notes be sold on an exchange.54 Where a
defendant puts no limitations on who can purchase the notes, offering them to any
member of the general public who would make the investment, this factor weighs toward
a finding that the instruments are securities.55 In Thompson, while the initial holders
were family and friends, Thompson later expanded distribution to anyone with $100,000
to invest.56

The court noted that “an evident interest in widening the scope of

distribution, combined with the broad availability of the notes can tip this factor strongly
in favor” of classifying the note as a security.57

50

Trust Co. of La. v. N.N.P. Inc., 104 F.3d 1478, 1489 (5th Cir.1997) (citing Nat'l Bank of Yugoslavia v.
Drexel Burnham Lambert, Inc., 768 F. Supp. 1010, 1015–16 (S.D.N.Y. 1991)); Stoiber v. S.E.C., 161 F.3d
745, 751 (D.C. Cir. 1998) (holding that thirteen customers is not considered to be “a broad segment of the
public”, but because Stoiber solicited individuals, not sophisticated institutions, this factor was dispositive.)

51 McNabb

v. S.E.C., 298 F.3d 1126, 1132 (9th Cir. 2002)

52

See Resolution Trust Corp. v. Stone, 998 F.2d 1534, 1539 (10th Cir.1993) (notes sold to a sophisticated
market, that were not purchased for any potential speculative or trading value, led to conclusion that no
common trading occurred).

53

Reves, 494 U.S. at 68, 110 S. Ct. 952.

54

Thompson, 732 F.3d at 1164 (citing Reves, 494 U.S. at 66, 110 S. Ct. at 951).

55

S.E.C. v. Wallenbrock, 313 F.3d 532, 539 (9th Cir. 2002).

56

Thompson, 732 F.3d at 1163.

57

Id. at 1164 (citing Wallenbrock, 313 F.3d at 539).

11

In contrast, a plan of distribution tilts against notes being securities where the
transaction was “unique, negotiated with a single buyer and negotiated term by term,
rather than being offered in a wholesale or potentially wholesale fashion.”58

In Robyn

Meredith, Inc. v. Levy, the court found that the nature of the note was a commercial
transaction, and did not constitute a security, because “the note here was not issued to
multiple parties, and neither party solicited the other in an attempt to raise money for
general capital to trade commodities. The note was “nonnegotiable” and was “offered to
a single party in connection with a specific commercial transaction.” 59
Here, the complaint does not expressly allege that the Promissory Notes at issue
were sold to a broad segment of the public. Notably, however, the Trust Deeds were
drafted before the Notes and were structured to allow broad distribution of notes, up to
$9.125 million. Indeed, the Trust Deeds expressly contemplated multiple notes and
investors by stating one note would not have priority over any other. Additionally,
Tripodi alleges that defendants entered into an arrangement whereby the Arnell
Defendants “would engage and solicit people and/or entities to lend money to Prime
West Jordanelle for the development of the Talisman project.”60

It appears that

defendants would have accepted any holders with sufficient funds to lend. Further,
Tripodi is an individual, not a sophisticated institution. Finally, Tripodi did not revise or
negotiate the terms and conditions for either Deed of Trust, which would be evidence of a
traditional loan, not an investment.61 All of these facts are consistent with a broad

58

Bass v. Janney Montgomery Scott, Inc., 210 F.3d 577, 585 (6th Cir. 2000).

59

Robyn Meredith, Inc. v. Levy, 440 F. Supp. 2d 378, 386 (D.N.J. 2006).

60

Dkt. No. 1 ¶¶ 19-21.

61

Dkt. No. 1, pgs. 6-10.

12

investment plan, not a single commercial loan transaction. Under the facts as alleged, this
factor also weights in favor of the Promissory Notes being securities.
3.

Reasonable Expectations of the Investing Public.
Reves’ third factor requires that the court examine the reasonable expectations of

the investing public and consider “instruments to be ‘securities' on the basis of such
public expectations, even where an economic analysis of the circumstances of the
particular transaction might suggest that the instruments are not ‘securities' as used in that
transaction.”62 Under this factor, the actual motivations of the individuals involved are
irrelevant. The court must view the transaction through the eyes of a reasonable investor,
not the expectations of the specific individuals actually involved. “Reasonable public
expectations will govern the characterization, even where the underlying economic
realities belie those expectations.”63
In applying this factor, the court is to consider whether the notes at issue would be
reasonably viewed by purchasers as investments.64 In Thompson, the defendant solicited
funds to grow a reserve to fund a project.65 The instrument expressly stated that it was
not a security, and that it was not an investment program.66 Nevertheless, the court held
that the factor leaned slightly towards a characterization of the note as a security, stating
that “[w]here the instruments are characterized by the originator as ‘investments’ and

62

Reves, 494 U.S. at 66, 110 S. Ct. 945.

63

Bass, 210 F.3d at 585 (citing Reves, 494 at U.S. 66–67, 110 S. Ct. 945); McNabb v. S.E.C., 298 F.3d
1126, 1132 (9th Cir. 2002).

64

Thompson, 732 F.3d at 1167.

65

Id. at 1155.

66

Id. at 1168.

13

there are no ‘countervailing factors’ that would lead a reasonable person to question this
characterization, ‘it would be reasonable for a prospective purchaser to take the
[originator] at its word.”’67
In this case, Welch argues that defendants solicited funds to aid in securing
longer-term financing.68 Welch contends that he never considered the loans to be
securities.69 The argument fails. First, his perceptions are irrelevant to the analysis. The
court must consider the reasonable expectations of the investing public in this scenario.
Second, the court may not consider arguments and evidence submitted to avoid the
default judgment. In the complaint, Tripodi alleges he was referred to the defendants
specifically for “high-yielding investment opportunities.”70 Further, the defendants
repeatedly emphasized the lucrative potential of the project, such as representing the
overall value of the project as $200 million.71

The structure of the Trust Deeds

contemplated multiple investors and multiple notes all secured by the same property.
These facts as alleged in the complaint lean decidedly in favor of finding that the Notes
constitute securities.
4.

Additional Factor Reducing Risk
Finally, the court must consider whether some factor exists, such as the existence

of a regulatory scheme, which significantly reduces the risk to the holder of the

67

Id. at 1167 (quoting Reves, 494 U.S. at 69, 110 S. Ct. 945).

68

Dkt. No. 126, at iv.

69

Dkt. No. 126, at 20.

70

Dkt. No. 1, at 10.
Dkt. No. 1, at 12.

71

14

instrument, making the application of the Securities Acts unnecessary.72 In this part of
the analysis, the court must “assess whether there are adequate risk-reducing factors such
as an alternate regulatory scheme that would ‘significantly reduce[ ] the risk of the
instrument’ to the lender, ‘thereby rendering application of the Securities Acts
unnecessary.’” 73
State regulations are a possible source of protection, but they do not necessarily
offer sufficient protection to render the protection of the securities laws unnecessary. For
example, the Second Circuit has held that a district court erred in concluding that state
regulation of mortgages afforded protection sufficient to render unnecessary the
application of the federal securities laws to these mortgage participations.74 Further, in
Thompson, the court held that holders were not adequately protected by the Utah State
Securities Division and that this factor tilted in favor of a finding that the instruments at
issue were securities.75 Welch cites the court to no authority or facts that would suggest a
different result in this case.
The existence of collateral, however, is a risk-reducing factor that may favor a
finding that the instruments are not securities.76 In this case, the Notes were secured by
the Trust Deeds. Nevertheless, the specific facts pled do not support a conclusion that the
existence of the collateral so significantly reduced the risk to Tripodi to ameliorate in

72

Resolution Trust Corp. v. Stone, 998 F.2d 1534, 1539 (10th Cir. 1993) (“The existence of other riskreducing factors diminishes the need for protection under the Securities Act.”).

73

McNabb v. S.E.C., 298 F.3d 1126, 1132 (9th Cir. 2002) (quoting Reves, 494 U.S. at 67, 110 S. Ct. 945)
(citations omitted).

74
75

76

Pollack, 27 F.3d at 815.
Thompson, 732 F.3d at 1169.
Stone, 998 F.2d at 1539; Bass, 210 F.3d at 585.

15

favor of the Notes not being securities. The Deeds of Trust were drafted to secure
multiple notes up to $9.125 million, nine times the amount Tripodi was induced to invest.
The Notes were included in a pool with no clear protection that the collateral would
assure that Tripodi would be paid as promised. Moreover, every note secured by the
Trust Deeds or to be secured in the subsequent sales of additional notes was afforded
equal priority in the event of default and foreclosure.77 All investors were on equal
footing and there was no limit on the number of investors whose notes may have been
secured by the same collateral. Thus, the collateral, in this case, provided at best limited
security for the investors. The Notes bore the hallmarks of an investment scheme,
structured to allow a broad range of investors, all on equal footing. In practical terms, the
repayment of the loans represented by the Notes depended on the ultimate success of the
project, not the credit worthiness of the borrowers or the value of the security. The fact
that realization of the returns promised in the Notes was primarily dependent on the
success of the venture favors strongly the conclusion that the Notes were securities.
In summary, all four of the Reves factors weigh in favor of the Notes Tripodi
purchased being securities. As alleged in the complaint, Tripodi was induced by the
defendants to participate in an investment scheme the success of which turned ultimately
on the defendants being able to raise sufficient funds to proceed with the Talisman
project. To realize the promised return on the investments, Tripodi was dependent upon
the success of the defendants to raise additional long-term funding and develop a
successful real estate project. The scheme contemplated multiple investors and provided
limited protection that Tripodi would be paid on the Notes he purchased. Finally, Welch
cites no factors that persuade that this particular investment has characteristics making it

77

Dkt. No. 45-2, and Dkt. No. 45-4.

16

appropriate to be added to the excepted list of non-securities. The Notes were sold to
Tripodi as an investment and functioned in every practical sense as investment securities.
Because the Notes were securities, the complaint states a cause of action for state and
federal securities fraud and there is no legal basis to enter judgment on the pleadings in
Welch’s favor.
Collateral Estoppel
Welch’s opposition to Tripodi’s motion for an order of non-dischargeability also
fails. The default judgment against Welch precludes him from having the debt discharged
in bankruptcy. The analysis of whether a default judgment for securities fraud should
have preclusive effect in a bankruptcy court so as to preclude discharge under 11 U.S.C.
§ 523(a)(19) turns on whether Congress preempted the common law of collateral estoppel
by declaring non-dischargeable “any judgment” from where a debt arises for securities
fraud.78 In In re Pujdak, the court concluded that Congress did preempt the common law
requirements for collateral estoppel. Thus, under § 523(a)(19) an issue need not be
actually litigated to have preclusive effect. Under common law collateral estoppel, a
default judgment would normally not have preclusive effect because the issue would not
have been actually litigated. In In re Pujdak, the court reasoned that by passing §
523(a)(19) Congress intended to punish persons “who commit securities-related misdeeds
by expanding the timeframe for the underlying judgment, settlement, order or decree to
be entered.”79 That same Congressional intent extended to precluding such persons from
having the benefit of the judgment being discharged in bankruptcy and relieving the

78

In re Pujdak, 462 B.R. 560 (Bankr. D.S.C. 2011); Meyer v. Rigdon, 36 F.3d 1375 (7th Cir. 1994).

79

In re Pujdak, 462 B.R. at 574.

17

victims from having to re-litigate the issue once judgment had been entered. The court
reasoned that § 523(a)(19) expressly states that it applies to “any judgment” and that a
default judgment falls within that language. The court further reasoned that a securities
fraud default judgment should not be dischargeable once a defendant has had the chance
to defend against the claim, and has chosen not to do so.80 The Pujdak court concluded
that a default judgment for securities fraud falls within § 523(a)(19) and is not
dischargeable.81
In Meyer v. Rigdon,82 the Seventh Circuit reached the same conclusion in
considering provisions of 11 U.S.C. § 523(a)(11), which are analogous and parallel to the
provisions of § 523(a)(19). In that case, the Court concluded “Congress wanted to
expand the preclusive effect given certain prior actions in bankruptcy discharge exception
proceedings.” After explaining common law collateral estoppel principles, the Court
concluded, “The plain language of section 523(a)(11), however, alters the common law
collateral estoppel rules with respect to default judgments . . . [and] requires the
bankruptcy court give preclusive effect to dispositions, like default judgments . . . .”83
The Court further concluded that by enacting the provision Congress preempted common
law principles of collateral estoppel.84

80

Id. at 578.

81

Id. at 560.

82

Meyer v. Rigdon, 36 F.3d 1375 (7th Cir. 1994).
Id. at 1380.

83

84

Id.

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The court finds the reasoning of In re Pujdak and Meyer persuasive.85 Section
523(a)(19) limits the ability of a person found liable for securities fraud from avoiding
the debt by having it discharged in bankruptcy. Congress intended by enacting the
section to make it easier for victims to recover damages for securities fraud and to avoid
having to retry an issue once a defendant has had a full and fair opportunity to defend
against the claim and has elected not to do so.

The section is applicable to “any

judgment” and there is no indication in the language of the section nor in the
circumstances of its adoption that a default judgment was not intended by Congress to
fall within this language. The court holds that a default judgment for securities fraud falls
within the provisions of § 523(a)(19).
In the prior default judgment entered against Defendant Welch, the court
expressly stated it was based on securities fraud. Under § 523(a)(19), that judgment has
preclusive effect and the debt is non-dischargeable.
CONCLUSION
After applying the “family resemblance” test articulated in Reves, the court
concludes the Promissory Notes were securities. Even construing all facts and inferences
in favor of Welch, the analysis of the four factors confirms that the Notes do not resemble
any of the articulated exceptions. On balance, all factors cut in favor of classifying the
Notes as securities. The same analysis counsels against this court creating a new category
of non-security to the Second Circuit’s list articulated in Reves. This court holds that
Defendant Welch cannot rebut the presumption that the Notes were securities.

85 McKinny v. Allison, 2013 U.S. Dist. LEXIS 155245 (E.D. N.C. 2013) does not support a different result.
In that case the judgment was entered upon a settlement agreement in which the defendant admitted no
wrongdoing.

19

The court DENIES Defendant Welch’s Motion for Reconsideration of Denial of
Motion to Set Aside Entry of Default. The court DENIES Defendant Welch’s Motion to
Set Aside Default Judgment. The court DENIES Defendant Welch’s Motion for
Judgment on the Pleadings.86
The Court GRANTS Plaintiff Tripodi’s Motion and enters an Order that the
Default Judgment entered in this case in Tripodi’s favor is not dischargeable in the
bankruptcy proceeding.87
DATED this 30th day of June, 2014.
BY THE COURT:

____________________________________
Clark Waddoups
United States District Judge

86

See Dkt. No. 126 for these three motions.

87

Dkt. No. 124.

20