In re: Alexander Sherman v. Igor Potapov

The Hon. David H. Souter, Associate Justice (Ret.) of the *
Supreme Court of the United States, sitting by designation.
United States Court of Appeals
For the First Circuit
No. 09-1572
IN RE: ALEXANDER SHERMAN,
Debtor.
ALEXANDER SHERMAN,
Appellant,
v.
IGOR POTAPOV, ET AL.,
Appellees.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Patti B. Saris, U.S. District Judge]
Before
Torruella, Circuit Judge,
Souter, Associate Justice, and Stahl, Circuit Judge. *
Evan Fray-Witzer, with whom Law Office of Evan Fray-Witzer was
on brief, for appellant.
Edward J. Fallman for appellees.
April 21, 2010

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SOUTER, Associate Justice. The appellant, Alexander
Sherman, and appellee Igor Potapov were among the five principals
in the Global Financial Group, Inc., which purchased a financial
management firm, Whitehorne and Co., Ltd. Potapov himself had an
account there and maintained one as agent for appellee B.A. Makden
Corporation.
Whitehorne steered three other clients into short
positions in technology stocks while that market sector was
booming, and when the shorted stocks’ continuing appreciation led
to margin calls, neither the three accounts nor their owners nor
Whitehorne itself had the money to respond. Another Whitehorne
principal, Irina Dunn, managed to obtain the approval of the firm’s
clearinghouse to reassign the disastrous investments (“rebill,” in
the industry euphemism) to the liquid accounts of Makden and
Potapov, who was abroad at the time. The move rescued the three
investors and kept the Whitehorne doors open for a time, but cost
the victims nearly $983,000.
Potapov’s discovery of the chicanery led to claims of
conversion, fraud and other defalcations by him and Makden against
Sherman and others, which were arbitrated under the rules of the
National Association of Securities Dealers. The arbitrators found
for the claimants in a general order that imposed joint and several
liability on the named Whitehorne principals, including Sherman and
Dunn. They promptly declared bankruptcy to escape the arbitration

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award but were met with adversary claims by Potapov and Makden that
the awards were immune to bankruptcy relief under the provision of
11 U.S.C. § 523(a)(4), which exempts from discharge any obligation
resulting from the debtor’s embezzlement. When the bankruptcy
court denied discharge, the Whitehorne principals appealed to the
district court, In re Dunn, No. 06-cv-10630-PBS (D. Mass. Feb. 27,
2007). The district judge read the arbitration award as
necessarily resting on a finding that Potapov had not authorized
the rescrambled transactions, but vacated the decree of non-
discharge and remanded for further proceedings to determine whether
any of the bankrupts had effected a conversion of the victims’
assets, and if so to determine whether the one or ones responsible
had acted with the intent necessary for embezzlement. After that,
the members of the Whitehorne group settled the adversary claims,
save for Sherman.
On remand, the bankruptcy court found that the crisis
created by the margin calls was placed before all the Whitehorne
principals then in residence, each of whom understood the rebilling
maneuver that Dunn would succeed in persuading the clearinghouse to
accept. The court specifically found that the only one of the
Whitehorne people still before the court, Sherman, had committed
embezzlement. Accordingly, the bankruptcy court again denied
discharge of the $983,000 debt, and was upheld on the second trip
to the district court, from which this appeal is taken.

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Although Sherman argues that he was never found
personally liable for conversion of the victims’ accounts, that is
simply at odds with the bankruptcy court’s findings and rulings.
The bankruptcy judge stated that in order to bar discharge for
embezzlement, it was necessary to find that the debtor appropriated
the victims’ property for his own benefit with fraudulent intent.
That is a substantially correct statement of law, and the judge’s
statement of conclusions make it clear enough that he found the
elements necessary to hold Sherman responsible as an embezzler.
There being no definition of embezzlement in § 523 or
elsewhere in the Bankruptcy Code, we assume that Congress wrote
with the common law in mind, Neder v. United States, 527 U.S. 1, 23
(1999), and United States v. Young, 955 F.2d 99 (1st Cir. 1992),
will suffice for an explanation of the traditional elements of
embezzlement. Embezzlement is “the fraudulent conversion of the
property of another by one who is already in lawful possession of
it.” Id. at 102 (internal quotation marks omitted). Thus, to
amount to embezzlement, conversion must be committed by a
perpetrator with fraudulent intent, and the question is whether the
bankruptcy court found it on Sherman’s part. Young is helpful
again, in its example of embezzlement by using entrusted money for
the recipient’s own purposes in a way he knows the entrustor did
not intend or authorize. Id. It is knowledge that the use is
devoid of authorization, scienter for short, see Palmacci v.

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Because Sherman was found liable in his own right, there is 1
no occasion to consider any issue of statutory imputed liability
under federal securities laws.
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Umpierrez, 121 F.3d 781, 786 (1st Cir. 1997), that makes the
conversion fraudulent and thus embezzlement, and it is just this
knowledge that the bankruptcy court found that Sherman had as a
participant in the conversion. The judge found that the principals
at the Whitehorne office were aware of the problem and of the
expedient Dunn proposed. Their positions in the company
necessarily gave them power over its actions, and there is no
evidence that Sherman objected or distanced himself in any way from
the course of action proposed and taken in the firm’s name; the
district court fairly characterized these facts as showing that
Sherman was “directly involved” in the rebilling.
While it is true that the bankruptcy judge did not make
an express finding that Sherman knew the action being taken was
unauthorized (as the arbitrators had necessarily found), the
judge’s conclusion leaves no doubt that he did so find. He spoke
of the elements of embezzlement as appropriation of another’s
property for one’s own purpose with fraudulent intent, and he could
hardly have found Sherman liable of fraudulent appropriation
without finding knowledge that authorization was wanting. The
bankruptcy court’s findings could have been expressed better, but
on this point they cannot be seriously doubted.1

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Sherman argues that knowledge of the unauthorized
rebilling is not enough to hold him to his debt under § 523,
however, because of another finding, that Dunn acted with the
object of keeping Whitehorne in operation and said as much to the
other principals as she prepared to victimize the solvent accounts.
In fact, the bankruptcy court was prepared to credit Dunn’s
testimony that saving the company was an object of Whitehorne’s
transfers, but found it irrelevant. Sherman calls this error, on
the authority of cases holding that a purpose of saving the
debtor’s company is a defense to the application of the
embezzlement exception to bankruptcy discharge, see, e.g., In re
Littleton, 942 F.2d 551, 556 (9th Cir. 1991); In re Fox, 370 B.R.
104, 117 (B.A.P. 6th Cir. 2007), a position consistent with the
general bankruptcy policy of allowing debtors to make a fresh
start, see, e.g., In re Baylis, 313 F.3d 9, 17 (1st Cir. 2002).
But Sherman’s argument is weaker than his list of
supporting citations would suggest. To begin with, a number of his
cases deal not with entrusted funds, as here, but with a debtor’s
obligation to repay loans out of business proceeds, see, e.g.,
Littleton, 942 F.2d at 552; In re Hartman, 254 B.R. 669, 671-72
(Bankr. E.D. Pa. 2000). More directly to the point, however, is
the tension between the save-the-company defense and the terms of
the statute. It provides that there will be no discharge for “any
debt . . . for . . . embezzlement,” § 523(a)(4). Nothing in the

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text narrows the traditional notion of embezzlement, and Sherman
points to nothing in the legislative record suggesting that
something more limited than common law embezzlement was intended.
The essence of the common law concept is knowing use of entrusted
property for an unauthorized purpose; there is no exception for
financial joyriding, see Young, 955 F.2d at 104 (unauthorized
“borrowing” with intent to repay is still embezzlement, the
borrowing being unauthorized), and nothing like a Robin Hood
limitation excusing defendants who misuse the entrusted property of
the solvent in order to save a poor company. Indeed, any excuse
for such a state of mind would be perverse here; saving the company
meant saving Sherman along with it (and not even Robin Hood could
have found Whitehorne, Sherman and the three luckless investors
more deserving than the victims whom chance, or their own prudence,
had spared from Whitehorne’s bad bet). Thus, a general rule of
narrow construction for anti-discharge provisions does not
neutralize the anomaly Sherman cries for; nor have we heard any
answer to the focused question, why Congress would have wished to
bar application of an anti-discharge provision for the benefit of
a debtor who knowingly violates the terms of his authorization to
use the property of another. There is no good reason against
applying the statute straightforwardly.
Sherman also claims that the district court stepped out
of bounds in finding facts, as a court sitting in an appellate

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capacity is not empowered to do. But there is no need to get into
this. The issue on remand to the bankruptcy court was whether
Sherman committed embezzlement, and the trial court found he did.
Any other facts, by whomever found, are beside the point in this
appeal.
The judgement of the district court is affirmed.

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