UNITED STATES OF AMERICA
Before the
COMMODITY FUTURES TRADING COMMISSION

Complainant Joseph D. Dennis, III ("Dennis") appeals from an Initial Decision ("I.D.") that dismissed his complaint due to a failure of proof. He raises challenges to the Administrative Law Judge's ("ALJ") liability and damages analysis. Respondents oppose the appeal and urge us to affirm the dismissal of the complaint.

As explained below, we conclude that the ALJ erred in two respects, but that the record supports dismissal of the complaint. Consequently, we affirm the result of the ALJ's decision.

BACKGROUND

I.

The facts and circumstances material to the disputes in Dennis's case share common elements with those material to the disputes resolved in our decision in Sommerfeld v. Refco, Inc., CFTC Docket Nos. 98-R009 and 98-R075 (CFTC September 29, 2000). Rather than repeat them here, we will rely on our description of the material facts and circumstances in the Sommerfeld decision. We supplement that description with a brief review of the facts and circumstances relating to Dennis's Refco account.

II.

Dennis opened an individual trading account with Refco in April 1997 and deposited $157,000 to margin his trading. During the account-opening process, he signed an acknowledgment that he had read and understood Commission-required disclosure documents. Dennis began trading strangle positions on April 21,1997. By April 29, 1997, the value of Dennis's account had declined to approximately $108,000. Dennis closed his account shortly thereafter.

III.

Dennis filed a reparations complaint seeking over $48,500 in damages in October 1997.¹ Dennis's complaint raised a variety of liability theories. The theories material to this appeal include two theories of direct liability and one theory of aiding and abetting liability. Specifically, the complaint alleged that respondents were directly liable for failing to: (1) disclose facts material to complainant's decision to open an account and trade strangles, and (2) furnish the risk disclosure documents required by Commission Rules 1.55 and 33.7. The complaint also alleged that respondents aided and abetted the Club's operation of an introducing broker ("IB") business without the registration required by Section 4d of the Act.

Respondents' joint answer denied all allegations of wrongdoing. They claimed that they had fulfilled all their disclosure obligations under the Act and Commission regulations, and noted that complainant had received the required risk disclosure statements and executed an appropriate acknowledgment. Respondents argued that because complainant's aiding and abetting theory focused on an alleged registration violation, it was not the proper subject of a reparations complaint. In this regard, they alleged that the Club's failure to register was not the proximate cause of complainants' damages.

IV.

The ALJ conducted a three-day hearing in San Diego, California in July 1998.² Apart from Dennis, Playan, and Zeller, the witnesses at the hearing were substantially the same as the witnesses at the hearing discussed in our Sommerfeld decision. The testimony of the common witnesses was also substantially the same.³

Dennis testified that Sy Gaiber ("Gaiber") recommended that he open an account with Refco. He testified that he met Rhea and Gaiber at the Club to complete the account-opening forms, that the forms were pulled from a drawer containing multiple sets of account-opening forms, that he had the forms for about two minutes, and that he signed the forms without reading them.

According to Dennis, Gaiber's strangle presentation at the Club's Wednesday seminars was deceptive because Gaiber asserted that there was no risk of loss. Dennis also testified that Rhea had touted Gaiber's expertise as a trader.

Dennis indicated that shortly after he sold his initial strangle positions on April 21, 1997, he learned that the market had approached the area that Gaiber had warned about in his seminars. Dennis said that he became concerned and contacted Rhea, who advised him that his exposure was unlimited. (Tr. at 35.) By the time that Dennis closed his account on April 30, 1997, its value had declined from the initial value of $157,000 to less than $108,000.⁴

V.

The ALJ issued his decision in April 1999. Playan v. Refco, Inc. [1998-1999 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,617 (Initial Decision Apr. 30, 1999) ("Playan"). The ALJ focused his analysis on the theories of liability discussed in complainants' posthearing brief. He considered two theories of direct liability - failure to disclose risk and failure to comply with Commission Rules 1.55 and 33.7; one theory of derivative (or agency-based) liability - deception perpetrated by Gaiber and Rhea; and one theory of aiding and abetting liability - Refco's aiding and abetting of the Club's failure to register as an IB.⁵

The ALJ found that complainants' aiding and abetting theory of liability failed because the record did not establish that the Club was obliged to register. In this regard, he emphasized that the record did not show that the Club received per trade compensation from Refco.⁶ He rejected complainants' argument that the Club's status should be assessed in terms of the Act's description of an IB's conduct rather than the definition the Commission adopted in Rule 1.3(mm). The judge found that the compensation that complainants addressed -- membership dues and fees - did not amount to compensation or profit under Commission Rule 1.3(mm). I.D. at 47,956.

The judge found that complainants failed to prove that Gaiber's strangle trading presentation at the Club's Wednesday seminars was deceptive. In this regard, he found that Dennis's testimony that Gaiber portrayed strangle trading as posing no risks was not credible. He noted that Dennis acknowledged that after he learned the market was fluctuating, he became concerned and contacted Rhea. The ALJ reasoned that such concern was incompatible with Dennis's purported understanding that strangle trading was riskless. I.D. at 47,956.

The judge also concluded that complainants failed to establish that the Club or its agents were acting for respondents for purposes of Section 2(a)(1)(A) of the Act. He found that the factors tending to show that a sufficient relationship existed did not outweigh the factors tending to negate the existence of a sufficient relationship. I.D. at 47,957-58.⁷

As to complainants' theories of direct liability, the ALJ ruled that they failed to show that respondents breached a duty to disclose material facts. The ALJ acknowledged that in some circumstances registrants are required to disclose more than the information included in Commission-required disclosure documents. He noted that in this case, however, respondents did not make any representations about either the likelihood of success or the risk of loss when complainants received the Commission-required disclosure documents. According to the ALJ, the absence of this type of representation distinguished the situation at issue here from the situation at issue in the Commission's decision in Knight v. First Commercial Financial Group, Inc., [1996-1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,942 (CFTC Jan. 14, 1997).⁸

Finally, the ALJ ruled that complainants did establish that respondents Refco and Dearborn violated Commission Rules 1.55 and 33.7,⁹ but concluded that the record did not show that the violations proximately caused their losses. The ALJ recognized that this type of violation raised a rebuttable presumption that complainants would have relied on the information disclosed in the Commission-required disclosure documents, but concluded that complainants' signed acknowledgments showed that they had read and understood the required disclosure statements prior to suffering any losses. In this regard, the ALJ found that Dennis's testimony that he did not read any of Refco's account-opening documents was not credible. Consequently, he found that Refco's and Dearborn's wrongdoing did not cause any damages to complainants. I.D. at 47,707-08.

Based on the foregoing analysis, the ALJ dismissed the complaints due to a failure of proof.

VI.

Dennis filed a timely notice of appeal in May 1999 and submitted an appeal brief in June 1999. As to respondents' direct liability, complainant argued that the judge erred by failing to hold that Refco had an obligation under the Act "to make necessary inquiries to determine whether [its] customers understand what they are getting into so that meaningful disclosure can be made." (Complainant's Appeal Brief at 12.) As to respondents' aiding and abetting liability, complainant argued that the ALJ erred in concluding that proof of compensation was a necessary element in a showing that the Club was obliged to register as an IB. He also claimed that the ALJ erred by adopting an unduly limited interpretation of Rule 1.3(mm)'s reference to indirect compensation.

Complainant also challenged the ALJ's analysis of reliance and proximate cause. He argued that the ALJ erred by basing his assessment of the harm flowing from Refco's and Dearborn's violations of Commission Rules 1.55 and 33.7 solely on complainant's execution of an acknowledgment. Complainant argued that the ALJ's discrediting of Dennis's testimony that he did not read the Commission-required disclosure documents was not supported by the record. Respondents' answering brief urged affirmance of the ALJ's dismissal of the complaint. As to direct liability, respondents supported the ALJ's conclusion that it was sufficient to disclose the information contained in the Commission-required disclosure documents.¹⁰ As for aiding and abetting liability, respondents emphasized that the Commission had clearly indicated that persons who refer clients to an FCM "on an occasional basis and without compensation" were not required to register as IBs. (Respondents' Reply Brief at 5.) ¹¹

Respondents also supported the ALJ's findings on reliance and proximate cause. They endorsed the ALJ's negative assessment of Dennis's credibility as well as his conclusion that the record rebutted any presumption of reliance arising from their alleged violation of Commission Rules 1.55 and 33.7.¹²

DISCUSSION

The issues raised in Dennis's appeal parallel those discussed in our Sommerfeld decision. As noted there, Commission precedent does not support complainant's contention that, as a general matter, a duty to inquire is part of a registrant's duty to disclose material facts. Sommerfeld at 24. Nor does the record show that the Club received the type of compensation or profit contemplated by Commission Rule 1.3(mm) for making referrals to Refco. Sommerfeld at 25.¹³

The ALJ's analysis of the harm flowing from Refco's and Dearborn's failure to furnish the Commission-required disclosure documents to Dennis directly turns largely on his assessment of complainant's credibility. As a general rule, the Commission defers to a presiding officer's credibility determinations in the absence of clear error. Secrest v. Madda Trading Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,627 (CFTC Sept. 14, 1989). Dennis's brief does not establish the type of clear error that warrants a de novo determination of his credibility.¹⁴ As in Sommerfeld, because complainant's testimony about the actual circumstances of the disclosure is not credible, there is no basis for disregarding the import of the acknowledgment that Dennis signed. Consequently, the presumption of reliance is rebutted in the circumstances of this case.

CONCLUSION

In light of the foregoing, we affirm the result of the ALJ's decision and dismiss the complaint.

IT IS SO ORDERED.¹⁵

By the Commission (Chairman RAINER and Commissioners HOLUM, SPEARS, NEWSOME and ERICKSON).

Jean A. Webb
Secretary of the Commission
Commodity Futures Trading Commission

Dated: September 29, 2000

1 The respondents that Dennis named in his complaint included Refco, Inc. ("Refco"), Dearborn Capital Management ("Dearborn"), John Frederick Miles ("Miles"), John Joseph Aiello ("Aiello"), and Tone N. Grant ("Grant"), the president of Refco. The Commission's Office of Proceedings declined to forward the complaint to Grant, and later concluded that the complaint should not have been forwarded as to Miles.

2 The hearing related not only to Dennis's claims but also to similar claims filed by Marion Playan ("playan") and Mina Zeller ("Zeller").

3 Lawrence Sommerfeld did not testify for complainants and neither Stanley Rhea ("Rhea") nor Emil Van Essen ("Van Essen") testified for respondents. The ALJ permitted the parties to introduce the transcripts of Sommerfeld's, Rhea's and Van Essen's earlier testimony into the evidentiary record of this proceeding.

4 Two put positions remained open until their expiration. Refco remitted a check to Dennis in the amount of $108,336.31 and later a check for $100.27, for accrued interest for May.

5 The ALJ's decision related to the claims made by Dennis and Playan. Because Zeller died while the consolidated proceeding was pending, the judge concluded that her claims had abated.

6 The ALJ interpreted language that the Commission included in the preamble explaining its adoption of Rule 1.3(mm) as indicating that persons who were not compensated on a per trade basis need not register. I.D. at 47,956 n.33 citing Final Rules on Registration and Other Regulatory Requirements, 48 Fed. Reg. 35,248, 35,251 (CFTC Aug. 3, 1983).

7 In making findings regarding these factors, the ALJ credited testimony offered by Miles, Gaiber and Johnson without specifically assessing their credibility. I.D. at 47,957-58.

8 In Knight, complainant sought to hold an FCM liable for the deceptive statements made by an unregistered individual (Falk) who exercised discretion over complainant's futures account under a written power of attorney. The record showed that (1) Falk referred Knight to the respondent FCM; (2) respondents sent account-opening documents for Knight to Falk; and (3) Knight's account executive (Ambre) acknowledged that he expected Falk to fulfill any responsibilities relating to the completion of the account-opening forms. The Commission ruled that Falk was acting for respondents when he presented the Commission-required disclosure statement to Knight and advised him that completing the documents was a formality. In reaching this conclusion, the Commission noted that respondents had a duty to furnish the Commission-required disclosure document to Knight, obtain Knight's signature on a dated acknowledgment, and retain the acknowledgment in accordance with Commission Rule 1.31. The Commission also indicated that the record showed that respondents did not have any direct contact with Knight prior to opening his account and observed that in this context, respondents either expected Falk to fulfill their obligations or "directly failed to fulfill its obligations under Commission Rule 1.55." Id. at 44,554.

9 Consistent with the Commission's analysis in Knight, the ALJ found that Dennis's receipt of Commission-required risk disclosure documents did not establish that Refco and Dearborn had fulfilled their duty to furnish those documents to complainants.

10 In this regard, they emphasized that the Commission has recognized that the scope of a registrant's duty to disclose varies with the nature of the registrant's relationship with the customer at issue. They argued that the scope of the duty in the circumstances of this case was narrow because Dennis did not rely on respondents to either advise him about strangle trading or exercise discretion over the trading in his Refco account. (Respondents' Reply Brief at 14.)

11 Respondents also supported the ALJ's conclusion that complainants failed to prove that the Club's failure to register played a substantial role in their losses. In addition, respondents argued that the record did not show either that respondents knew that the Club had a duty to register or that they sought to aid the Club in evading its duty. On the latter point, they noted that the record showed that they had specifically asked NFA for advice about the Club's registration status.

12 Respondents reiterated their prior argument that the relevant regulations do not require an FCM to supply required disclosure documents to customers directly.

13 The ALJ's focus on per trade compensation was unduly narrow, but the error was harmless in the circumstances of this case.

14 The ALJ erred in relying on testimony by Gaiber, Johnson, and Miles without evaluating their credibility. See Sommerfeld at 23-24. In the circumstances of this case, however, that error was also harmless.

15 Under Sections 6(c) and 14(e) of the Commodity Exchange Act, 7 U.S.C. §§ 9 and 18(e)(1994), a party may appeal a reparation order of the Commission to the United States Court of Appeals for only the circuit in which a hearing was held; if no hearing was held, the appeal may be filed in any circuit in which the appellee is located. The statute also states that such an appeal must be filed within 15 days after notice of the order.