UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
|In the Matter of:||)||CFTC Docket No. 97-12|
|Curtis McNair Arnold||)||ORDER MAKING FINDINGS AND|
|)||IMPOSING REMEDIAL SANCTIONS|
|London Financial, Inc.,||)|
On July 30, 1997, the Commodity Futures Trading Commission ("Commission") filed a Complaint and Notice of Hearing against Curtis McNair Arnold ("Arnold") and London Financial, Inc. ("LFI") (collectively, "Respondents"). The Complaint charges that Respondents violated Sections 4b(a)(i) and 4o(1) of the Commodity Exchange Act, as amended ("Act"), 7 U.S.C. §§ 6b(a)(i) and 6o(1), (1994), and Commission Regulation 4.41(a) and (b), 17 C.F.R. §§ 4.41(a) and (b) (1999).
In order to dispose of the allegations and issues raised in the Complaint, Respondents have submitted a Joint Offer of Settlement ("Offer"), which the Commission has determined to accept. Without admitting or denying the allegations in the Complaint or the findings in this Order, and prior to any adjudication on the merits, Respondents acknowledge service of the Complaint and of the Order. Respondents consent to the use of the findings in this Order in this proceeding and in any other proceeding brought by the Commission or to which the Commission is a party.1
The Commission finds the following:
Since at least 1992, Arnold and LFI have acted as commodity trading advisors ("CTAs") by offering and selling to the public the Pattern Probability Strategy ("PPS") trading system, a video, a book and a training manual teaching PPS, and various advisory services offering the trading signals generated by PPS, including facsimile services. Respondents also acted as CTAs by providing PPS trading signals to two commodity pools, one from 1990-1994 and one from 1993-1994. Since at least 1996, Respondents also have offered and sold to the public a publication entitled Systems USA, distributed by mail and over the Internet. Systems USA purports to "track" the performance of various trading systems authored by Arnold and other vendors, and offers and sells these systems and services related to these systems.
Respondents distributed direct-mail promotional literature through two publishers in 1994 and 1995 and directly in 1995. The Promotions misrepresented the profits and rates of return generated by Arnold's trading pursuant to PPS and failed to disclose that many of the representations concerning the performance of PPS were based on hypothetical trading of PPS rather than actual trading . Respondents' direct Promotion and the Systems USA publication also failed to disclose that many of the representations concerning the performance of PPS were based on hypothetical trading and further failed to provide the warning regarding the limitations of hypothetical trading required by Section 4.41(b) of the Regulations .
Curtis McNair Arnold, who resides at 460 Bella Vista Court, North Jupiter, Florida 33477 and also maintains a summer residence at 1112 Roosevelt Trail, Unit 15, Windham, Maine 04062, is not currently registered with the Commission in any capacity. Arnold is the president, sole shareholder and principal of LFI., a Florida corporation.2
London Financial, Inc. is a Florida corporation that is not registered with the Commission in any capacity. LFI conducts business from 460 Bella Vista Court, North
Jupiter, Flordia 33477. Arnold is the sole principal and shareholder of LFI.
1. Arnold's Trading System
In 1987 Arnold developed the PPS, a trend-following commodity futures trading system. PPS and the advisory services based on PPS provided specific buy, sell and stop recommendations. Arnold, both individually and through LFI, has been marketing PPS since at least 1989. Arnold has periodically engaged in mass-mailings to promote his system, and has sent out, or caused others to send out, promotional material for PPS products to at least 50,000 prospective clients.
At least three direct mail Promotions offering to sell PPS were disseminated to the public during 1994 and 1995. One of the Promotions was prepared and distributed by Respondents; the other two Promotions were prepared and distributed by publishers retained by Respondents. Arnold was the source of all the performance representations contained in the promotions.
2. The 1994 Promotion
In 1994, a publisher distributed promotional literature to between 20,000 and 40,000 people offering for sale Arnold's book, entitled "Timing the Market," and a PPS training video and workbook. The promotion contained the following materially false statements concerning PPS and the results of trading pursuant to PPS: (1) Curtis Arnold made over 2500% actual profits in 5 years; (2) Curtis Arnold increased a "$7500 small, conservative trader's account to over $200,000 in a 5 year period"; (3) the purported profit figures were supposedly based on "real trading, with real dollars "; and (4) Curtis Arnold's worst year ended with an 81% profit. In fact, Arnold's $7500 account never increased to $200,000 nor ever made 2500% "actual profits ." Moreover, during the five year period from 1988 to 1993, Arnold's worst year resulted in less than an 81% gain.
3. The 1995 Promotion
A second publisher prepared and distributed promotional material to between 45,000 and 90,000 people in 1995, which offered for sale the PPS training video and computer software. This promotion contained the same three fraudulent representations discussed above that were made in the 1994 Promotion.
In addition, the 1995 Promotion represented that a client could increase a $20,000 account to $646,944 in seven years by making 50% per year, and that "PPS profits are double that ." In fact, a $20,000 account, over seven years at a 50% annual return, would grow only to $341,719. More importantly, PPS' profits were not double this seven-year result .
The 1995 Promotion also included two charts with accompanying captions which described two supposedly successful trades as follows: (1) A chart titled "British Pound December 1992" and captioned "This British Pound trade nailed the high and low while generating $29,487 income per contract; " and (2) A chart titled "S&P 500 Composite Future December 1987" and captioned: "The October `87 market crash was no problem for PPS. Profits of $76,000 per contract illustrate the power and safety of PPS trading." In fact, neither of these trades was generated by PPS or made in Arnold's account .
Finally, the 1995 Promotion contained a series of statements referring to "returns" or "profits," including: (1) "In each of 10 years, the fledgling system had achieved returns between 100% and 200% based on a twenty-five thousand dollar account trading one contract" ; and (2) "PPS can offer you consistent profits with minimal risks. Imagine making 123% per year for the last ten years trading single contracts with a maximum drawdown equal to 4% of profits. Imagine turning $25,000 into $1,487,184 in five years while risking only 2% per trade." In fact, Arnold did not actually trade pursuant to PPS for 10 years, PPS never actually made 123% per year for ten years, never made between 100% and 200% for each of 10 years; and never turned $25,000 into $1,487,184 in five years.
4. Respondents' 1995 Direct Promotion
Respondents prepared and disseminated their own direct mail promotion in 1995, which offered a copy of Arnold's book and a PPS training video. The Respondents' Promotion contained the same materially false statements concerning PPS and the results of trading pursuant to PPS which were contained in both the 1994 Promotion and 1995 Promotion, as follows: (1) "Curtis Arnold made over 2500% actual profits in just 5 years"; (2) Curtis Arnold increased a "$7500 small, conservative trader's account to over $200,000 in a 5 year period. This is real trading, with real dollars" ; and (3) "Curtis Arnold's worst year ended with an 81% gain in profit."
In fact, as previously discussed, Arnold's $7500 account never increased to $200,000 and never made 2500% "actual profits." In addition, Respondents' Promotion, sent out in 1995, failed to disclose that in 1994 Arnold suffered a loss of 16 % in his own account, and that two commodity pools that traded pursuant to PPS signals lost approximately 15% and 16%, respectively, of their value in 1994.
Respondents' Promotion also included a chart captioned "PPS Time Line" that reflected results based on hypothetical trading; however, the promotion failed to disclose that that the results were hypothetical and also failed to include a statement regarding the inherent limitations of hypothetical trading required by Commission regulation.
5. Systems USA
Starting in 1996, Respondents offered and sold a monthly publication, Systems USA, which purported to track the performance of various commodity futures trading systems, including PPS and numerous other systems created by Respondents. Respondents also offered and sold to the public these systems and facsimile services for each of the systems. The performance results reflected in Systems USA were based completely on hypothetical trading . However, Systems USA never disclosed that and failed to include the required cautionary statement concerning the limitations of hypothetical trading results.
D. LEGAL DISCUSSION
1. Respondents Violated Sections 4b(a)(i) of the Act
Section 4b(a)(i) of the Act prohibits any person, in or in connection with any order to make or the making of a futures contract, for or on behalf of any other person, from cheating or defrauding, or attempting to cheat or defraud, such other person. Misrepresentations and omissions of material facts made with scienter regarding futures transactions constitute fraud under Section 4b(a) of the Act. In the Matter of R&W Technical Services, Inc., [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶27,582 at 47,740-47,741 (CFTC Mar. 16, 1999), aff'd in relevant part, R&W Technical Svcs., Inc. v. CFTC, 205 F.3d 165 (5th Cir. 2000). See also Saxe v. E.F. Hutton, 789 F.2d 105, 110 (2d Cir. 1986); Kelley v. Carr, 442 F. Supp. 346, 351-54 (W.D. Mich. 1977), aff'd in part, rev'd in part, 691 F.2d 800 (6th Cir. 1980).
A statement is material if it is substantially likely that a reasonable investor would consider the matter important in making an investment decision. TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976); Sudol v. Shearson Loeb Rhoades, Inc., [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,748, at 31,119 (CFTC Sept. 30, 1985). In general, all manner of omissions and misrepresentations of material fact regarding futures transactions violate the antifraud provisions of the Act, including omissions and representations concerning the likelihood of profit and other matters that a reasonable investor would consider material to his investment decisions. See, e.g., First Nat. Monetary Corp. v. Weinberger, 819 F.2d 1334 (6th Cir. 1987); CFTC v. US Metals Depository Co., 468 F. Supp. 1149 (S.D.N.Y. 1979); CFTC v. Crown Colony Commodity Options Ltd., 434 F. Supp. 911 (S.D.N.Y. 1977).
Claims, such as those made by Respondents, that a purchaser of PPS would make substantial profits while incurring minimal risks by trading according to the signals generated by the PPS software, are fraudulent. CFTC v. Commonwealth Financial Group, Inc., 874 F. Supp. 1345, 1354 (S.D. Fla. 1994) (finding that statements to potential customers such as "the likelihood of possible profit is near certain," or "over the last seven years every $10,000 invested has netted an average of as much as $50,000 in profits based on the underlying futures" exceeded "mere optimism" and violated Section 4b of the Act); CFTC v. Crown Commodity Options, Ltd., 434 F. Supp. 911 (S.D.N.Y. 1977) (sales pitches were misleading and inaccurate when "they conveyed the distinct impression that extraordinary short-term profits were all but certain to be realized by investors").
Respondents' representations that hypothetical performance and profits made with PPS were actual performance and profits, knowing that such claims were not based on actual trading, but rather on hypothetical trading, are also fraudulent. "Because simulated results inherently overstate the reliability and validity of an investment system, and because extravagant claims understate the inherent risks in commodities trading, a reasonable investor would find [such] fraudulent misrepresentations to be material." R&W Technical Services, Ltd. v. Commodity Futures Trading Commission, 205 F.3d 165, 170 (5th Cir. 2000) See also CFTC v. Skorupskas, 605 F. Supp. 923, 933 (E.D. Mich. 1985) (solicitations aided through use of false or deceitful performance tables violated Section 4b(a)).
Section 4b(a)(i) requires that the material misrepresentations and omissions of material facts be made "in connection" with futures transactions. Fraudulent statements that induce members of the public to purchase software that generates specific buy and sell signals for commodity futures trading satisfy the "in connection with" requirement of Section 4b(a). R&W Technical Svcs., 205 F.3d 165, 173 (5th Cir. 2000). See also Hirk v. Agri-Research Council, Inc., 561 F.2d 96 (7th Cir. 1977) (noting that the "in or in connection with" requirement should be interpreted flexibly to include deceptive conduct that occurs prior to the opening of an actual commodity trading account).
Finally, liability under Section 4b(a) of the Act requires proof of scienter, i.e., proof that the respondent committed the alleged wrongful acts "intentionally or with reckless disregard for [his] duties under the Act."Hammond v. Smith Barney, Harris Upham & Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,617 at 36,659 n.21 (CFTC March 1, 1990); CFTC v. Savage, 611 F.2d 270, 283 (9th Cir. 1979) (finding of scienter supported by proof of recklessness). Respondents' willful misrepresentations and omissions concerning the performance record of PPS and Arnold's trading pursuant to PPS, and other misrepresentations concerning the likelihood of making a profit, were made intentionally (or with reckless disregard). Accordingly they constitute fraud in violation of Section 4b(a)(i) of the Act.
2. Respondents Violated Section 4o(1) of the Act and Regulation 4.41(a) and (b).
Section 4o(1) of the Act prohibits CTAs from (a) employing any device, scheme or artifice to defraud any client or participant or prospective client or participant, or (b) engaging in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or participant or prospective client or participant. Section 4.41(a) of the Regulations prohibits a CTA or principal thereof from advertising in a fraudulent or misleading manner. Section 4.41(b) of the Regulations makes it unlawful for a CTA to fail to include the required warnings about the limitations of trading performance numbers based upon hypothetical or simulated data. 3
In order to establish a violation of Section 4o of the Act and Section 4.41 of the Regulations, the Division must prove that the respondent was (i) a CTA or, with respect to Section 4.41 of the Regulations, a principal thereof, and (ii) either (a) employed any device, scheme, or artifice to defraud any client or prospective client, or (b) engaged in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client. Section 4o(1) of the Act which also requires the use of the mails or any means or instrumentality of interstate commerce, prohibits both registered and unregistered CTAs from defrauding their clients. CFTC v. Savage, 611 F.2d 270, 281 (9th Cir. 1979) (holding that defendant with made false reports to customers, engaged in "wash" trades and held himself out to the public as a CTA without being registered with the Commission). Section 4.41 of the Regulations also applies to all CTAs, regardless of whether those CTAs are required to be registered.
Section 1(a)(5) of the Act defines a CTA as a person who "for compensation or profit, engages in ...advising others, either directly or through publications, writings, or electronic media as to the value of or the advisability of trading" in futures contracts. Respondents gave commodity futures trading advice for compensation or profit and, therefore, operated as CTAs. See R & W Technical Services, 205 F.3d at 174 (concluding that sellers of commodity trading software functioned as CTAs); CFTC v. British American Commodity Options Corp., 560 F.2d 135, 141 (2d Cir. 1977), cert. denied, 438 U.S. 905 (1978)(a firm that "offer[ed] opinions and advice, and issued analyses and reports concerning the value of commodities" to customers, was a CTA under the Act.).
The same conduct by Respondents that violated Section 4b(a) of the Act also violated Section 4o(1) of the Act and Regulation 4.41(a) because he engaged in that conduct in his capacity as a CTA. Skorupskas, 605 F. Supp. at 932-33 (the same conduct that violates Section 4b can violate Section 4o(1)); In re Slusser, [1998-1999 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶27, 701 at 48, 315 (CFTC July 19, 1999), aff'd in part, remanded in part, 210 F. 3d 783 (7th Cir. 2000) (`[w]here the record establishes that the respondents engaged fraudulent conduct in violation of Section 4b the Division has ... surpassed its burden of proof with respect to section 4o").
Accordingly, Respondents' willful misrepresentations and omissions concerning the performance record of PPS and Arnold's trading pursuant to PPS, and other misrepresentations concerning the likelihood of making a profit, constitute fraud in violation of Section 4o(1) of the Act.
Respondents also violated Section 4.41(b) of the Regulations by presenting hypothetical or simulated performance results without accompanying those results with the prescribed cautionary statement.
3. Arnold is liable as a Controlling Person for LFI's Fraud
To be liable as a controlling person under § 13(b) of the Act, a person must possess the requisite degree of control and either: 1) knowingly induce, directly or indirectly, the acts constituting the violation; or 2) fail to act in good faith. In re Glass, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,337 at 46,561-4 (CFTC April 27, 1998) ("A fundamental purpose of Section 13(b) is to allow the Commission to reach behind the business entity to the controlling individual and to impose liability for violations of the Act directly on such individual as well as on the entity itself."); In re Apache Trading Corp., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,251 at 34,766 (CFTC Mar. 11, 1992). Arnold exercised a high degree of corporate control at LFI. Arnold determined the activities in which LFI engaged and prepared and/or reviewed each of the three promotions disseminated by or on behalf of Respondents in 1994 and 1995. He knew that various representations in the promotions were false and did not do anything to correct the false statements. He knew that other statements were based entirely on hypothetical trading, yet did nothing to disclose that fact or to advise prospective clients that there were limitations to hypothetical trading results. Arnold thereby knowingly induced LFI's fraud and he is, therefore, liable for that violative conduct as a controlling person pursuant to § 13(b) of the Act.
JOINT OFFER OF SETTLEMENT
The Respondents have submitted a Joint Offer of Settlement, a copy of which is attached hereto, in which without admitting or denying the findings in this Order, Respondents:
A. Acknowledge service of the Complaint and the Order;
B. Admit the jurisdiction of the Commission with respect to the matters set forth in the Complaint and the Order;
1. a hearing;
2. all post-hearing procedures;
3. judicial review by any court;
4. any objection to the staff's participation in the Commission's consideration of the Offers;
5. all claims which they may possess under the Equal Access to Justice Act, 5 U.S.C. § 504 (1994) and 28 U.S.C. § 2412 (1994), as amended by Pub. L. No. 104-121, §§ 231-32, 110 Stat. 862-63, and Part 148 of the Regulations, 17 C.F.R. §§ 148.1, et seq., relating to or arising from this action; and they shall not assert any right under the Equal Access to Justice Act to seek costs, fees, or other expenses relating to, or arising from, this proceeding;
6. any claim of Double Jeopardy based upon the institution of this proceeding or the entry in this proceeding of any order imposing a civil monetary penalty or any other relief.
D. Stipulate that the record basis on which this Order is entered consists of the Complaint, the Order and the findings to which each has consented in the Joint Offer, which is incorporated in this Order.
E. Consent, solely on the basis of the Joint Offer, to the entry of the Order in the form attached hereto, which makes findings of fact and findings of violations, and:
1. directs Respondents to cease and desist from violating Sections 4b(a)(i) and 4o(1) of the Act, 7 U.S.C. §§ 6b(a)(i) and 6o(1), (1994), and Commission Regulation 4.41(a) and (b), 17 C.F.R. §§ 4.41(a) and (b) (1999);
2. prohibits Respondents from trading on or subject to the rules of any contract market for a period of three (3) years;
3. directs Arnold to pay a civil monetary penalty of one hundred thousand dollars ($100,000); and
4. orders Respondents to comply with their undertakings as set forth below.
FINDINGS OF VIOLATIONS
Based on the foregoing, the Commission finds that Respondents violated Sections 4b(a)(i) and 4o(1) of the Act and Section 4.41(a) and (b) of the Regulations.
Accordingly, IT IS HEREBY ORDERED THAT:
A. Arnold and LFI shall cease and desist from violating Sections 4b(a)(i) and 4o(1) of the Act and Section 4.41(a) and (b) of the Regulations;
B. Arnold and LFI shall be prohibited from trading on or subject to the rules of any contract market, and all contract markets are directed to refuse Arnold and LFI trading privileges, beginning on the third Monday after the date of this Order and continuing for a period of three (3) years;
C. Arnold shall pay a civil monetary penalty in the amount of one hundred thousand dollars ($100,000) within ten (10) days of the date of this Order. Arnold shall make such payment by U.S. postal money order, certified check, bank cashier's check, or bank money order, made payable to the Commodity Futures Trading Commission, and addressed to Dennese Posey, Division of Trading and Markets, Commodity Futures Trading Commission, 1155 21st Street, NW, Washington D.C. 20581 under cover of a letter that identifies Arnold and the name and docket number of the proceeding. A copy of the cover letter and the form of payment shall be simultaneously transmitted to Director, Division of Enforcement, Commodity Futures Trading Commission, at the following address: 1155 21st Street, NW, Washington D.C. 20581; and
D. Respondents shall comply with the following undertakings:
1. never to apply for registration with the Commission in any capacity or to seek exemption from registration;
2. never to engage in any activity that requires registration with the Commission, including, but not limited to, directing any current or prospective client's commodity interest account; soliciting, accepting or receiving any funds, revenue, or other property from any person, or soliciting prospective customers, related to the purchase or sale of any commodity futures or options on commodity futures contracts;
3. never to act as a principal, agent, or officer of any person registered, exempted from registration or required to be registered with the Commission; and
4. neither of the Respondents, nor any of their agents or employees under their authority or control, shall take any action or make any public statements denying, directly or indirectly, any finding in this Order, or creating, or tending to create, the impression that this Order is without a factual basis; provided, however, that nothing in this provision shall affect each Respondent's (i) testimonial obligations; or (ii) right to take legal positions in other proceedings to which the Commission is not a party.
The provisions of this Order shall be effective on this date.
|By the Commission.|
|Dated: August 14, 2000||______________________|
|Jean A. Webb|
|Secretary to the Commission|
Commodity Futures Trading Commission
1 Respondents do not consent to the use of the Joint Offer or this Order, or the findings to which they have consented in the Offer, as the sole basis for any other proceeding brought by the Commission other than a proceeding brought to enforce the terms of this Order. They do not consent to the use of the Offer or this Order by any other person or entity in this or any other proceeding. The findings to which they have consented in the Offer, as contained in this Order, are not binding on any other person or entity in any other proceeding.
2 Arnold was a principal and was registered with the Commission as an associated person ("AP") of Arnold Curtis, Inc., a CTA, from September 25, 1985 to September 30, 1986, and was also a principal and registered AP of Arnold Curtis McNair, a CTA, from January 13, 1989 to October 20, 1990. From July 7, 1987 to March 29, 1988, Arnold was registered as an AP of JFH Commodities Co., a CTA, and from April 21, 1987 to September 28, 1990, Arnold was registered as an AP of International Futures Strategists, Inc., an introducing broker ("IB") and CPO.
3 Section 4.41(b) of the Regulations provides, in relevant part: "(1) No person may present the performance of any simulated or hypothetical commodity interest account, transaction in a commodity interest or a series of transactions in a commodity interest ... unless such performance is accompanied by one of the following: (i) The following statement: 'Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve the profits or losses similar to those shown'; or (ii) A statement prescribed pursuant to rules promulgated by a registered futures association pursuant to Section 17(j) of the Act; (2) If the presentation of such simulated or hypothetical performance is other than oral, the prescribed statement must be prominently displayed."