UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
CHARLES A. and ALISON McDANIEL,
|CFTC Docket No. 97-R057|
ALISON McDANIEL as TRUSTEE for
ROBERT B. MINER TRUST
AMERIVEST BROKERAGE SERVICES, a/k/a
TRADELINE BROKERAGE SERVICES, LLC,
ROBERT IAN GORRIE, WALTER F. PRICE, and RB&H FINANCIAL SERVICES :
CFTC Docket No. 97-R058
OPINION AND ORDER
Respondents Amerivest Brokerage Services a/k/a Tradeline Brokerage Services LLC ("Tradeline"), RB&H Financial Services ("RB&H"), Walter Price ("price") and Robert Gorrie ("Gorrie") jointly appeal from an Initial Decision ("I.D.") that ordered them to pay $55,000 plus interest and costs to the McDaniel Family Trust ("Family trust") and $31,000 plus interest and costs to the Robert B. Miner Trust ("Miner trust").1 The Administrative Law Judge ("ALJ") based his awards on findings that (1) respondents Price and Gorrie fraudulently induced Alison McDaniel, the trustee of both the Family trust and Miner trust, to follow Price's trading recommendations and (2) respondents jointly misled McDaniel about the status of the trusts' accounts by sending her account statements that misstated the relationship between the equity in the trust accounts and the margin required to maintain the trusts' open positions.
Respondents argue that the ALJ denied them a fair hearing by unduly limiting discovery and refusing to admit reliable and relevant evidence. They also argue that the ALJ misapplied applicable legal standards and made factual findings that are unsupported by the record. Complainants defend the ALJ's analysis and urge the Commission to affirm all aspects of his decision.
For the reasons explained below, we vacate the ALJ's decision and dismiss both complaints.
As noted above, Alison McDaniel is the trustee of both trust-complainants. Her husband, Charles McDaniel, is the co-trustee of the Family trust. Alison and Charles McDaniel are also the beneficiaries of the Family trust. Alison McDaniel's two children are the beneficiaries of the Miner trust.
Alison McDaniel ("McDaniel") played the primary role in the trust-complainants' futures and options trading.2 At the time of the hearing in these matters, McDaniel was forty-eight-years old. She had graduated from high school and worked as an artist. Prior to opening the accounts at issue in this case, McDaniel had taken a futures trading course offered by Ken Roberts and engaged in "paper trading" for several months. She had also traded a small futures and options account at another FCM. She lost about $2,000 as a result of trading in this account.
McDaniel learned about Tradeline from a television commercial. She called Tradeline and talked to respondent Price. After several telephone conversations and a visit to Tradeline's offices where she met respondent Gorrie, McDaniel opened the Family trust account with RB&H in April 1996.3 As part of the account opening process, McDaniel completed RB&H's customer application form and executed an acknowledgement that she had read and understood the Commission-mandated disclosure document. She initially funded the account with a $10,000 deposit on April 19, 1996.
During April, trading in the Family trust account focused largely on corn, oats, wheat and soybean futures contracts.4 The account did sell a three-contract strangle position in U.S. dollar index options that remained open at the end of the month.5 Initially, futures trades executed for the account earned substantial profits on liquidation. Accrued losses, however, led to a $4,500 margin call on April 29. The following day, McDaniel deposited an additional $15,000 to margin trading. This deposit brought McDaniel's cumulative investment in the Family trust account to $25,000.
Consistent with Commission requirements, RB&H sent McDaniel a confirmation statement ("daily account statement") every day that it executed a trade for the Family trust. The daily account statements listed trades that were executed on a particular day as well as positions that remained open at the end of that day. They also disclosed different figures representing perspectives on the account's value at the end of the day.6 Finally, the bottom of the statements disclosed three margin-related numbers.7
The daily account statement for April 30, 1996 illustrates RB&H's disclosure. The statement indicated that there were four futures positions and three option positions open in the Family trust account. It disclosed that the account balance segregated U.S. dollars had been $22,497.65 at the end of April 29, but had risen to $37,497.65.8 It showed that the total open trade equity was ($21,425) and that the net market value of options was ($2,310).9 It disclosed an account value at market of $13,762.65. As for margin-related figures, it indicated that: (1) the initial margin requirement was $27,741, (2) the maintenance margin requirement was $21,162, and (3) the margin deficit was $11, 668.35.
RB&H also sent McDaniel a monthly account statement after the close of the last business day each month. The monthly account statement included a list of each trade executed for the Family trust during the month as well as a list of all positions that remained open at the end of the month. The monthly account statement also disclosed different figures representing perspectives on the account's value at the end of the month.10 They also disclosed numbers representing different perspectives on the account's performance that month.11 The number appearing at the end of the monthly statement reflected the account value at market.
The monthly account statement for April 1996 illustrates RB&H's disclosure. It listed all the trades that were executed during the month and indicated that there were four futures positions and three option positions open in the Family trust account. It showed that the account balance segregated U.S. dollars had been zero at the beginning of the month but had risen to $37,497.65 by the end of the month. It disclosed a net futures profit for the month of $11,009 and a net option premium for the month of $1,488.65. It showed that the total open trade equity was ($21,425) and that the total option market value was ($2,310). At the end of the statement, RB&H disclosed that the Family trust's account value at market was $13,762.65. This represented a loss of almost 45 percent of the $25,000 that McDaniel had deposited into the account.
The Family trust's May monthly statement disclosed that several trades in U.S. dollar index options had been executed. It also disclosed a substantial number of trades in corn, oats, wheat, and soybean futures contracts as well as infrequent trades in Swiss franc futures contracts and wheat and soybean call options. It showed that there were wheat, soybean and U.S. dollar index option positions open in the account. It disclosed a net futures loss for the month of $18,738.24 and a net option premium for the month of $8,854.15. It showed that the total option market value was ($16,310). At the end of the statement, RB&H disclosed that the Family trust's account value at market was $11,303.56.
The Family trust's June monthly statement disclosed a deposit of an additional $10,000 during the month. It showed that most trades executed that month were in U.S. dollar index option contracts and that there were two wheat option positions and several U.S. dollar index option positions open at the end of the month. It disclosed a net futures profit for the month of $162.24, a net option premium for the month of $11,437.55, and a realized option memo P&L of ($700). It showed that the total option market value was ($21,707.50). At the end of the statement, RB&H disclosed that the Family trust's account value at market had risen to $27,505.85. This represented a loss of about 23 percent of the $35,000 that McDaniel had deposited.
McDaniel opened the Miner trust account in June. The Miner trust's June monthly statement indicated that $15,000 was deposited on June 14, 1996. It showed that all trades during the month were in U.S. dollar index options. It disclosed a net option premium for the month of $8,940.70. It showed that the total option market value was ($9,370) and that the account value at market was $14,570.70. This represented a net loss of about three percent of the $15,000 that McDaniel had deposited into the account.
The monthly account statements for both accounts disclosed similar information for the period June 1996 through January 1997. They showed that most trades were either in U.S. dollar index options or futures. They also disclosed trades in a variety of option contracts (corn, wheat, soybeans, sugar, heating oil, Eurodollar, Japanese yen and Treasury bonds) and futures contracts (corn, oats, wheat, soybeans, live hogs, heating oil, unleaded gas, Treasury bonds and Swiss francs). The statements for many months disclosed an account balance segregated U.S. dollars larger that the amount of funds that McDaniel had deposited to that point. For every month, however, the statements disclosed an account value at market less than the amount of funds that McDaniel had deposited to that point.12
For example, the Family trust's January 1997 monthly statement disclosed an account balance segregated U.S. dollars of $82,521.39. It also indicated that the account value at market had fallen to $3,961.39. This represented a loss of more than 93 percent of McDaniel's $57,000 deposit. The Miner trust's January monthly statement disclosed an account balance segregated U.S. dollars of $67,641.01. It also indicated that the account value at market had fallen to $6,311.01. This represented a loss of almost 80 percent of McDaniel's $31,000 deposit.
Both trusts' February monthly statement showed that that the account was closed during the month. Each account's remaining open positions were transferred to another FCM.
McDaniel was dissatisfied with the results of the trading in both accounts at the time she transferred the remaining positions. She had a telephone conversation with respondent Gorrie shortly after the transfer. During that conversation, McDaniel told Gorrie that she would not pursue any claims against respondents if Gorrie would restore the equity in her daughter-in-law's account at Tradeline.13 Gorrie subsequently returned Linda McDaniel's $5,600 deposit.
McDaniel was acting pro se when she contacted the Commission about the trusts' reparation complaints. None of her individual written submissions independently provides a clear summary of either the nature of the trusts' claims or the specific facts and circumstances underlying those claims. With the assistance of the Commission's Office of Proceedings, McDaniel submitted several documents describing different aspects of the trusts' dispute with respondents. On April 28, 1997, the Office of Proceedings deemed McDaniel's overall description of the dispute sufficiently developed to forward it to respondents for a response. McDaniel, however, continued to refine her description of several aspects of the trusts' claims even after respondents had submitted their answer.
In the context of the issues before us, a detailed review of each of McDaniel's written submissions is not warranted. Instead, we highlight those aspects that outline the general elements of McDaniel's version of the events at issue.
McDaniel's submissions expressed passionate feelings about the losses the trusts suffered as a result of their dealings with respondents. McDaniel emphasized that the trusts suffered almost a complete loss of the funds invested with Tradeline and insisted that losing money was not consistent with the trusts' trading objectives. She complained that such losses evidenced a breach of fiduciary duty that was tantamount to criminality. She referred to respondents' trading practices as incompetent, careless, reckless, ill advised and poorly monitored.
Aside from these complaints about the results of respondents' trading, McDaniel focused on allegations of deception. For example, she claimed that respondent Price had falsely claimed an expertise in trading U.S. dollar index options and had provided false assurances that his strategy for trading U.S. dollar index options was extremely conservative and the "best kept secret in the industry." McDaniel also stated that Price had initially promised to earn approximately a 90 percent return by Christmas and then retreated to a promise of approximately a 60 percent profit by Christmas. She emphasized that in discussing the success of his trading strategy, Price failed to disclose that clients using his U.S. dollar index options trading strategy had recently lost all their money because they kept positions open too long.
McDaniel made more limited references to several other types of wrongdoing. One of the documents that McDaniel submitted referred to a "suspicion of churning" and another claimed that during a conversation with McDaniel, Price admitted that he churned clients' accounts earlier in his career. McDaniel also claimed that Price failed to follow an instruction to include contracts other than the U.S. dollar index in the trusts' trading, as well as her December 1996 instruction that he pull back from trading and move the accounts to cash. In addition, McDaniel stated that respondents had breached their fiduciary duty because they knew the accounts in question were trusts and that one of them was set up to provide for the educational needs of children but traded in reckless disregard of these facts.
McDaniel offered only a general description of the facts underlying these claims of wrongdoing. She acknowledged that she contacted Tradeline because she was dissatisfied with the account maintained with a different FCM. McDaniel also admitted that she initially controlled the trading in the Family trust account, but claimed that her trading experience was mixed and that she was not willing to risk more than the $10,000 she had deposited. McDaniel claimed that Price's deceptive statements about his U.S. dollar index options trading strategy convinced her to change her approach.
McDaniel acknowledged that she had taken a commodity trading course and traded another futures account prior to opening her Tradeline account, but emphasized that she had no knowledge of "more sophisticated trades" such as straddles and strangles and felt both "extremely incompetent" and "scared to death to trade." She admitted that Price conferred with her prior to entering trades, but claimed she had simply put her trust in his judgment, because she was a believer in "letting people do what they do best."14
McDaniel insisted that the accounts did well for many months and seemed to be "flourishing nicely" between July and November. She claimed that she was unaware of the precarious position the trust accounts were in until January 1997 when she learned that Price had lost all the money her daughter-in-law had invested with Tradeline. In this regard, she explained that neither she nor her husband could "ever totally comprehend the complexities of the statements that flooded us almost on a daily basis."
Respondents' June 1997 answers presented a starkly different version of the relevant events. In addition to generally denying all allegations of wrongdoing, respondents emphasized that McDaniel had presented herself to Tradeline as "a knowledgeable investor in commodities, futures and options" who was "schooled in trading, having taken extensive investment courses and seminars." They alleged that McDaniel not only understood and gave prior approval for each trade executed for the trust accounts, but also "totally controlled" the trading in the accounts. The answers emphasized that McDaniel had signed both an acknowledgment that she received written risk disclosure and a statement indicating that respondents made no representations contrary to the written risk disclosure statement.
The answers also raised accord and satisfaction as an affirmative defense. In support, respondents alleged that McDaniel had agreed that the trusts' claims would be discharged if $5,619.10 were paid to Linda McDaniel. Because the agreed amount had been paid, the answers explained, the trusts' claims should be deemed discharged.15
The Director of the Office of Proceedings separately forwarded the two trusts' complaints for assignment to a presiding officer in June 1997. While both complaints were assigned to the same ALJ, the Family trust's complaint was forwarded for resolution in a formal decisional proceeding and the Miner trust's complaint was forwarded for resolution in a summary decisional proceeding.16 Sometime later, the ALJ apparently concluded that it would be more efficient to resolve the issues raised in both complaints in a formal decisional proceeding. As a result, he conducted a single oral hearing to develop the factual record on the disputes raised in both cases and issued a single initial decision.
Since none of the parties objected to the ALJ's de facto consolidation of these cases, our review of the procedural history of the cases does not focus on the minor differences in the parties' submissions in each case. None of the distinctions is important to the issues material to the outcome of this proceeding.
There were two notable developments during the discovery period. On July 15, 1997, counsel for respondents spent several hours questioning McDaniel about her disputes with Tradeline. McDaniel was not under oath during the questioning, but a court reporter attended and prepared a transcript of counsel's questions and McDaniel's responses. The caption at the beginning of the transcript creates at least an appearance that what the parties have referred to as McDaniel's "deposition" was part of this reparations proceeding. The Commission's reparations rules, however, do not require any party to provide discovery by participating in a deposition.
The record does not clearly establish how this deposition was arranged. McDaniel suggests that counsel for respondents led her to believe that they were going to discuss settlement. Respondents have bypassed several opportunities to explain the circumstances of the deposition. We need not resolve this question in the context of this decision.17 The deposition itself, however, plays a material role in one of the procedural errors that respondents raise on appeal.
The second development involved respondents' discovery requests on the trust complainants. Respondents served McDaniel with interrogatories and requests for production during July 1997. As noted above, the trusts' complaints acknowledged that McDaniel had both training about and experience with futures trading, but claimed that she had no knowledge of sophisticated trading techniques such as strangles and was unable to totally comprehend the complexity of the account statements that RB&H provided. In contrast, respondents' answer described McDaniel as a knowledgeable investor in both futures and options who both understood and controlled all the trading in the trusts' accounts. Many of respondents' discovery requests focused on information relevant to this aspect of the parties' dispute. For example, respondents sought information and documents relating to investments that McDaniel had made for the trusts during the previous five years, the brokers that McDaniel had consulted during the previous five years, as well as investment seminars attended and financial publications received during this period. Respondents also sought documents that might be used to assess the credibility of McDaniel's version of events, such as notes and memoranda McDaniel may have prepared to memorialize her conversations with respondents.18
McDaniel refused to provide the bulk of either the information or documents that respondents sought. McDaniel claimed that most of respondents' requests were contrary to Commission Rule 12.30(b)(1) and (2).19 She characterized the information and documents that respondents sought as "unnecessary, irrelevant and abusive" and complained that the requests had been issued to "distract attention from [the trusts' claims]." McDaniel also noted she had provided respondents with substantial information during her four-hour deposition on July 15.
Respondents then filed a motion to compel with the ALJ. The motion reviewed each item that McDaniel had refused to respond to and explained why the requested documents or information were relevant to their defense. On September 4, 1997, the ALJ issued an order that refused to compel responses to most of respondents' discovery requests. Complainants were ordered to produce information about their trades in futures or options on futures during the previous two years. The judge found that the other interrogatories respondents posed related almost exclusively to economic and intellectual suitability issues that were not raised in the complaints. In addition, he criticized respondents for failing to end their interrogatories with a question mark. As for respondents' requests for production, the ALJ stated that the "information sought by respondents is irrelevant to the issues in this case."
Both sides filed a prehearing memorandum in September 1997.20 In most cases, the submission of prehearing memoranda is the prelude to an oral hearing on the disputes described in the parties' memoranda. In this case, however, their submission was the first step in an unusual process that ultimately redefined some of the contours of the parties' dispute.
After the ALJ issued an order setting the hearing in these matters for December 9, 1997 in Los Angeles, McDaniel retained counsel to represent the trust complainants. Counsel for the trusts then sought to postpone the hearing and serve discovery requests on respondents. The ALJ initially resisted all efforts to postpone the scheduled hearing. Early in December, however, the ALJ conducted an unrecorded telephone conference with counsel for both sides and determined that the hearing would be held on January 9, 1998 after counsel for complainants filed amended complaints clarifying the trusts' allegations. During the conference, the ALJ also apparently ruled that respondents could not use McDaniel's deposition as evidence at the hearing.21
The ALJ followed up the conference by issuing an order on December 4, 1997. The order established deadlines for complainants' submission of an amended complaint and respondents' submission of an amended answer. The order indicated that discovery would not be reopened. Nevertheless, the judge ordered respondents to produce: (1) a sample of the office and floor orders that respondents used to record trades entered for complainants' accounts, and (2) for sample trades that involved deep-out-of-the-money options, the exchange register identifying the executing broker, the executing FCM, the customer type indicator ("CTI"), opposing broker, and writer of the option.22
Counsel for the trusts filed amended complaints about three weeks prior to the date of the hearing in this matter. According to the amended complaints, when McDaniel opened the Family trust account in April 1996 and the Miner trust account in June 1996, she did not understand that commodity investments involved a significant degree of risk. They claimed that Price and Gorrie touted Tradeline as a "premier firm" and portrayed Price as "a financial professional of the highest caliber who was extraordinarily knowledgeable and had an established track record of making money for his clients." They alleged that prior to opening the Family trust account, McDaniel informed Price that her tolerance for risk was $10,000.
The amended complainants alleged that McDaniel became "overwhelmed and vulnerable" less than one week after the Family trust account was established because the account experienced "great fluctuations" and such market volatility frightened her. When McDaniel expressed her fear to Price, the complaints stated, he urged her to follow his "safe, slow and conservative strategy" rather than her "gun slinging" approach. In the course of several conversations, Price represented that he had acquired considerable expertise and enjoyed profitable results trading U.S. dollar index options. The amended complaints alleged that Price touted his trading strategy as "the best kept secret in the industry" and described his approach as "extremely conservative yet potentially able to yield good returns."
According to the amended complaints, McDaniel deposited $55,000 into the
Family trust account and over $33,000 into the Miner trust account as the result of Price and Gorrie's representations. They claimed that the initial success of Price's trading increased McDaniel's trust in Price and led her to recruit friends to open accounts. When trading results deteriorated, the complaints continued, Price both misrepresented the trading results and continued to misrepresent the sophistication and safety of his trading strategy. During this period, Gorrie failed to advise McDaniel that the trust accounts were in a precarious state.
The complaints explained that McDaniel later discovered that (1) Price had neither expertise nor a conservative strategy for trading dollar indexes; (2) U.S. dollar index contracts were subject to the same level of risk as most other commodities; (3) Price had not disclosed prior unsuccessful trading in U.S. dollar index option contracts; and (4) Price had not disclosed that account losses could be mitigated by balancing or liquidating positions at an earlier point. The complaints alleged that these deceptive acts amounted to fraud under the Act and that Tradeline was liable for Price and Gorrie's wrongdoing due to both its principal/agent relationship and status as a controlling person. The amended complaints did not make any references to churning or trading to generate commissions.23
Two days prior to the hearing, counsel for complainants belatedly raised an issue regarding expert testimony. The ALJ's novel approach to resolving that issue plays a prominent role in respondents' appeal from his decision.
In an earlier ruling, the ALJ had stated that the direct testimony of expert witnesses must be submitted at the time that a party filed a prehearing memorandum. This order clearly contemplated that expert witnesses would appear at the hearing for cross-examination by opposing counsel. This would be the required process under Commission precedent.24 Counsel for the trusts, however, sought leave to present the expert testimony of Edward Horwitz via telephone during the hearing because, at the last minute, respondents were unable to provide her with information necessary to determine the losses the trust accounts had suffered.25
Nothing in the record indicates that the ALJ ruled on this motion. Nevertheless, one day prior to the hearing, counsel for complainants submitted a letter attaching what she called the "finalized schedules we intend to introduce at the hearing tomorrow." The schedules the letter referred to were attached to a document entitled "Report of Edward B. Horwitz." (the "Horwitz Report"). Two of the schedules were entitled "Margin Status Summary." One included figures relevant to the margin status of the Family Trust account and the others included figures relevant to the margin status of the Miner Trust account. The other two schedules were entitled "Monthly Statistical Summary." Again, one included figures relevant to the status of the Family trust account and the other included figures relevant to the Miner Trust accounts.
The other two documents attached to the Horwitz Report were not in the nature of
schedules. One was a document describing Horwitz's qualifications, licenses, and experience. The other was a set of charts illustrating price trends for the U.S. dollar index. Counsel's letter did not address the role these documents played in her plan to introduce the schedules at the hearing.
Complainants' expert expressed his opinion on three major points in the Horwitz Report. First, he focused on the transactions involving U.S. dollar index options and noted that the options were out-of-the money. He indicated that the risks of selling these options was "extremely high" due to the leverage involved. In his view, an exit strategy such as automatic liquidation when the underlying futures contract approached the option's strike price played a necessary role in prudent use of a strategy focused on the sale of out-of-the money U.S. dollar index options. Indeed, Horwitz claimed that such an exit strategy was "essential" because otherwise ten winning trades would be wiped out by one modest losing trade.
Horwitz also addressed the margin calculation in the account statements that RB&H had provided. He did not discuss different possible methods for calculating excess equity under margin rules, apparently assuming that there was only one proper calculation method. In Horwitz's view, RB&H "screwed up their calculations" of the funds available to margin positions in the trust accounts. He opined that a proper calculation of the funds available to margin positions showed that the Family trust account was in "margin trouble" from late May forward, and that the Miner trust account was in similar trouble from mid-July forward.
Finally, Horwitz commented on calculations relevant to an analysis of excessive trading in the two trust accounts. Horwitz did not explain how he determined the class of commissions and fees that he included in his calculation of monthly commission-to-equity ratios.26 Given the level of the monthly rates that he had calculated, Horowitz opined that it was impossible for the accounts not to lose money due to the high number of transactions entered that might have been based on respondents' margin miscalculations.
At the January 9, 1998 hearing, counsel for respondents objected to the admission of both the Horwitz Report and the attached schedules. (Tr. at 83.) The ALJ ruled that the schedules were admissible as a "summary" prepared under the direction of complainants' counsel. (Tr. at 84.) As for the opinions expressed in the Horwitz Report itself, the ALJ ruled that they were admissible as "argument" that respondents would have an opportunity to rebut. Id.27
Another of the ALJ's evidentiary rulings also merits a brief mention. During respondents' counsel's examination of McDaniel, he attempted to use McDaniel's July 15, 1997 deposition to refresh her recollection about why she had transferred funds from the Family trust account to the Miner trust account. The ALJ instructed him to refrain from referring to the deposition, explaining that "we prohibit the use of depositions in these proceedings." (Tr. at 69.)28
McDaniel, Price, and Gorrie were the only witnesses at the hearing. McDaniel's testimony downplayed her prior investment experience and emphasized the trust she had placed in Price's and Gorrie's ability to take care of her money and inform her about what was going on. She acknowledged taking a Ken Roberts course on futures trading, but emphasized that he focused mainly on futures trading and claimed that he "sugar coated it very nicely and made it sound wonderful." (Tr. at 54-55.) She claimed that even after she attended the course, she "really didn't have a great understanding of options in the commodities market." (Tr. at 55.) Nevertheless, she admitted that she knew commodity trading was "dangerous," and began trading in commodities because it was "interesting," "different," and a "challenge." (Tr. at 59, 60.)
McDaniel also briefly testified about her experience trading securities. She explained that her initial investment for the Miner trust was in mutual funds. She acknowledged that she stopped trading mutual funds because they were "boring" and she "was not making any money with them." (Tr. at 67.) When asked about trading in stock options, McDaniel admitted that she could "comprehend" options in the stock market. Nevertheless, she claimed she did not understand the options transactions that Price did for her Tradeline account.29
McDaniel characterized the account that she maintained with another FCM prior to the time that she opened the trust accounts at Tradeline as "very small " and limited to "simple long contracts" in corn and sugar. (Tr. at 46.) She explained that her loss of a little less than $2,000 "terrified" her, and that she closed that account because her account executive was "extremely busy" and she felt Price "could give better advice." (Tr. at 48.)
McDaniel testified that she learned about Tradeline through a television commercial and that she decided to trade through Price because he presented himself well and she felt he had both "a great deal of knowledge of the commodities market" and honesty and integrity. (Tr. at 48.) She insisted that she only intended to risk $10,000 when she opened the Family trust account but acknowledged that the initial results of her grain trading - a $12,000 gain trading oats -- were "absolutely thrilling." (Tr. at 49.) She realized her trading was "very dangerous," however, when she lost that profit the following day. (Tr. at 49.)
According to McDaniel, it was at this point that Price touted his U.S. dollar index options strategy as "very safe, very conservative." and "the best kept secret in the industry." (Tr. at 49.)30 She claimed that Price contrasted his strategy with what he termed McDaniel's "gun slinging" approach to trading and insisted that Price did not discuss the risk of employing his strategy. (Tr. at 49-50.) McDaniel did acknowledge that Price had explained how his strategy would work, including the fact that her option positions would make money "if the dollar stayed at its range." (Tr. at 64.) She denied, however, understanding that there would be risk if the dollar broke out of its trading range. She explained that Price told her "there was very little down side risk" because "he had the proper positions in place." (Tr. at 61.)
McDaniel testified that once the account started trading dollar index options, she followed Price's recommendations. (Tr. at 50.) She explained that she did the best she could to understand the positions and "condoned them," but claimed that she would have never done "those trades without [Price's] recommendation." (Tr. at 50.) McDaniel insisted that she was unaware that either account was "in trouble" until sometime around December 1997 when her friend Patricia Bragg told her that Price's trading had resulted in the loss of her entire account. (Tr. at 51.) She acknowledged that she received margin calls, but claimed that Price advised her to "ignore them." (Tr. at 61.) She explained her deposit of additional funds into both accounts as a reflection of the fact that they were "doing so well." (Tr. at 57, 63.)31
Price's testimony was in sharp conflict with McDaniel's. He denied representing himself as an expert in U.S. dollar index option trading (Tr. at 20, 28), and insisted that he always covered both the risks and the rewards when explaining investments to clients. (Tr. at 88.)
According to Price, when he told McDaniel that one of strategies he traded was called a delta neutral option strategy, he explained that it promoted the selling of puts and calls to bring the premiums into the account by assuming that the market would stay within a defined range. (Tr. at 31-32.) While he acknowledged describing the strategy as "a slow process because you're waiting for time to kill an option," Price testified that he never told complainant that the strategy was conservative. (Tr. at 29.) He said that he had disclosed that the strategy's "maximum upside" would only be the amount of the premiums minus commissions, whereas the "maximum downside" risk would be unlimited. (Tr. at 32-33, 89, 98.)
Price testified that he talked with McDaniel on a daily basis (Tr. at 37, 94), and that McDaniel was aware of the conditions in both of her accounts at all times. (Tr. at 92-94.) Price also claimed that they had discussed "liquidation value" and "the fact that things [were] not that good and this account [was] down from its opening level." (Tr. at 37, 94.) When asked at what point he told McDaniel that the accounts were losing money, however, Price claimed that he "[didn't] know how to answer that question." (Tr. at 37.)32
Price acknowledged that option positions with accrued losses were held open because his strategy took advantage of time and the tendency of the option value to deteriorate. (Tr. at 99.) He also acknowledged that profitable positions were liquidated more quickly. (Tr. at 101.) He observed that the latter practice was not a part of his strategy, but explained that McDaniel had urged him to liquidate profitable positions quickly in light of information she had learned at a "Wade Cook course." According to Price, this course led McDaniel to believe that the secret to making money was "take little profits all the time." (Tr. at 101.)
Price testified that the largest losses in the trusts' accounts were due to a "major anomaly" that he described as "when the dollar made almost a straight up 500 point move [in] a month or something." (Tr. at 102.) He explained that at the time the accounts were transferred, "[t]here was quite a bit of cash in there, but the liquid value was very low." (Tr. at 103.)
Respondent Gorrie testified that he was the president of Tradeline and Price's supervisor. (Tr. at 105.) He stated that he approved Price's delta neutral strategy and that it was employed properly to meet complainants' trading objectives. (Tr. at 121.) According to Gorrie, the trusts' accounts suffered large losses due to an abrupt market move, and not due to Price's negligence or mismanagement. (Id.)33
Gorrie was asked several questions about the analysis included in the Horwitz Report. He testified that Horwitz's claim that the margin in the trust accounts was miscalculated was "ludicrous." (Tr. at 107.) He explained that RB&H was a member of the Chicago Mercantile Exchange ("CME") and had calculated applicable margin requirements in accordance with CME's Standard Portfolio Analysis of Risk ("SPAN") requirements.34 He indicated that Horwitz had erred in his analysis because he failed to recognize that the funds available to margin positions included both the cash in the account and the value of open trade equity. (Tr. at 109.)
Gorrie also testified about the account statements that RB&H provided to McDaniel. He explained that the account statements included an entry for the "[a]ccount value at market" which was determined based upon "all of the positions in the account." (Tr. at 112.) He testified that when the accounts were closed in February 1997, "on the one account [a] check was [issued] of approximately $50,000, and another one it was somewhere in the neighborhood of $37,000." (Tr. at 114.) Gorrie further explained that both the open positions and the cash value of the two accounts were transferred to McDaniel's new FCM. (Tr. at 115.)35
The parties filed several post-hearing submissions. Complainants submitted both a post-hearing brief and proposed findings and conclusions of law.36 Respondents made similar submissions37 and also filed a letter from an attorney in CME's audit department that indicated that the trust accounts were properly margined between January 1, 1997 and February 9, 1997. The letter indicated that the Miner trust account was also properly margined from February 9,
1997 until February 19, 1997, but that the Family trust account was undermargined during this period. Counsel for complainants filed a response to the CME letter, emphasizing that it only addressed a portion of the time that the trust accounts were open. Counsel also challenged the letter's conclusions as "wrong" and "absurd."
The ALJ issued his Initial Decision in August 1998. McDaniel v. Amerivest Brokerage Services a/k/a Tradeline Brokerage Services LLC., [1998-1999 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶27,407 (Aug. 17, 1998). The judge concluded that Gorrie's testimony was not credible.38 The judge did not specifically assess the credibility of McDaniel's or Price's testimony, but he generally credited McDaniel's version of events over Price's version of events. See, e.g., I.D. at 46,914 (finding that Price did not explain the risk of writing options but emphasized that his strategy was safe and the best kept secret in the industry).
After a brief review of McDaniel's background, commodity-related training and initial experience trading futures, the ALJ found that McDaniel "kn[ew] very little about the nuances of futures and options trading." I.D. at 46,912. He noted McDaniel's and Price's conflicting description of the latter's solicitation for his option writing strategy, and found that:
Price persuaded McDaniel to switch from grain trading to writing puts and calls on the dollar index by emphasizing profits and down playing the risks and . . . he did so to inflate the excess equity with premiums earned, which in turn allowed the account to be churned to generate commissions.
I.D. at 46,912.39 The ALJ also found that all dollar index trades were based on Price's recommendations and that "Gorrie approved of Price's conduct." Id.
The ALJ then turned to the daily account statements provided by RB&H. He found that beginning with the May 1996 statement, RB&H's daily account statements consistently overstated the excess equity for the Family trust account.40 I.D. at 46912-13. He made a similar finding about statements for the Miner trust account.41 He also found that the false excess equity reports misled McDaniel about the true status of both trust accounts. I.D. at 46,913.
In making these findings about RB&H's account statements, the ALJ cited solely to the statements themselves, which had been marked as Complainants' Exhibit 1 at the hearing. He did not explain how he had determined the appropriate method for calculating the excess equity. He did state that the account statements "fully support[ed]" Horwitz's conclusion that RB&H calculated its excess equity number by "comparing the margin requirement with the cash balance instead of the account value." Id. (emphasis in the original). The ALJ found that this error was deliberate and part of an effort to mislead McDaniel. Id.42
In light of these findings, the ALJ concluded that respondents violated Section 4b of the Act by undertaking a scheme to cheat complainant trusts by fraudulently inducing McDaniel to write put and call options and providing false information about excess equity to conceal the true status of the accounts. As to damages, the ALJ concluded that "all losses incurred in both accounts on and after April 23, 1996 [were] directly related to the fraudulent conduct of respondents." Id. As a result, he awarded the Miner trust $31,465 plus interest and awarded the Family trust $56,728 plus interest. I.D. at 46,915.43
Respondents filed a timely notice of appeal in September 1998. They submitted their appeal brief in November 1998. Along with their brief, respondents submitted two types of new evidence: (1) a transcript of McDaniel's July 15, 1997 deposition and (2) a copy of a margin handbook issued by the Joint Audit Committee in August 1994. Complainants filed their answering brief in December 1998.
Respondents' brief raises challenges to the ALJ's procedural rulings, factual assessments, and substantive analysis. For example, it claimed that the ALJ denied respondents a fair hearing by imposing undue limitations on their discovery of information relevant to an assessment of McDaniel's sophistication and trading experience.44 As for the substance of the ALJ's decision, it argued that the judge committed legal error by making findings related to a churning claim that was neither raised in the trusts' amended complaints nor litigated with the consent of the parties.
Respondents' brief primarily focused on what it claimed were multiple errors in the ALJ's factual assessments. For example, it claimed that the judge based key findings on the Horwitz Report despite his own ruling that the Report would be treated as argument rather than evidence, and endorsed McDaniel's version of events without giving appropriate weight to testimony and documentary evidence that contradicted her version.45
Complainants' brief argued that the ALJ's restrictions on respondents' discovery did not harm them because they had obtained comparable information when they deposed McDaniel.46 It claimed that the record showed that the commissions the trusts paid were so high that it was almost impossible for their accounts to earn a profit, but emphasized that the judge had not awarded any damages as a result of his churning-related findings.
Complainants' brief argued that any errors in the ALJ's use of the Horwitz Report were harmless. It suggested that it was unnecessary to determine whether RB&H's calculation of excess equity was appropriate because Price and Gorrie's own testimony showed that the account statements were sufficiently confusing to mislead McDaniel. It contended that McDaniel's testimony was credible and consistent with the record as a whole.47
As noted above, the ALJ refused to compel complainants to respond to the bulk of respondents' discovery requests. The ALJ ruled that many of the requests sought irrelevant information and noted that respondents' interrogatories did not end with a question mark. As a result of this ruling, respondents were denied access to information and documents concerning: (1) investments that McDaniel had made for the trusts during the previous five years; (2) the brokers that McDaniel had consulted during the previous five years; (3) investment seminars that McDaniel attended and financial publications she received during this period; and (4) notes and memoranda McDaniel may have prepared to memorialize her conversations with respondents.
In both formal and summary reparation proceedings, a party may discover unprivileged materials that are relevant. Commission Rule 12.30(1). At the same time, the presiding officer may limit the scope of discovery in order to protect a party from undue burden or expense. Commission Rule 12.30(2). In this case, the ALJ did not cite either undue burden or expense as the basis for limiting respondents' discovery. In essence, he ruled that respondents were seeking discovery beyond the scope of Commission Rule 12.30(1).
This ruling was a clear abuse of the ALJ's discretion. From the outset of this proceeding, McDaniel sought to portray herself as naļve and trusting despite her training and experience in futures and options trading. Respondents clearly recognized that an effort to undermine this portrayal was central to their defense. All of the information noted above is relevant to assessing both the credibility and reliability of McDaniel's self-portrait. By depriving respondents of this information, the ALJ significantly undermined their ability to impeach McDaniel's testimony through cross-examination. Consequently, his ruling deprived respondents of their opportunity for a fair hearing.48
In ordinary circumstances, this conclusion would lead to a remand for additional discovery and a new hearing. Because we conclude that even the current record is sufficient to undermine the reliability of McDaniel's version of events, however, we conclude that further proceedings are unnecessary in the circumstances of this case.49
The record shows that the ALJ also erred in considering the Horwitz Report, the attached schedules, and the related documents complainants submitted. As noted above, the ALJ found that the amount of excess equity disclosed in the daily account statements RB&H provided to McDaniel was deceptive. This was one of the three conclusions that Horwitz reached in his Report. In his decision, however, the ALJ claimed that he had made this determination by examining the daily account statements themselves. According to the judge, the figures in the account statements were not only consistent with the figures disclosed in the margin summary schedules prepared by Horwitz, but also fully supported Horwitz's conclusion that RB&H miscalculated the amount of excess equity in the trusts' accounts.
This aspect of the ALJ's analysis is, at best, confusing. The key set of figures disclosed in Horwitz's margin summary schedules is in a column that he labeled "Actual Excess/Deficit." This column reveals Horwitz's calculation of the amount of each trust's excess equity (or margin deficit) for the days that trades were entered. The figures in this column do not appear on any of the account statements that the ALJ said he was relying on. Moreover, they cannot be derived from the figures that do appear on the account statements without performing a calculation. To perform the relevant calculation, one must determine the appropriate method for calculating excess equity (or margin deficit). In essence, Horwitz's Report and margin summary schedules were based on an implicit expert opinion that he knew and applied the only legitimate method for calculating excess equity. Indeed, his core judgment on the issue of excess equity was that RB&H was applying the wrong method to calculate the figures it disclosed.50
The ALJ's decision does not address the proper method for calculating excess equity or his basis for concluding that the method RB&H used was incorrect. In these circumstances, we infer that, despite his protests to the contrary, the ALJ was relying on Horwitz's implicit claim that he did know the only legitimate method. By doing so, the ALJ was improperly giving evidentiary weight to expert testimony that had not been properly admitted to the record.51
If Horowitz had appeared and the hearing and been subject to cross-examination, respondents might have asked him about the method that he used in his calculations and why he believed it was the only legitimate method for RB&H to use in calculating excess equity.52 Moreover, they may have asked him to explain the apparent inconsistency between his view and the view expressed in the letter prepared by staff at the CME.53 The ALJ foreclosed these inquiries by failing to address the issue raised in complainants' motion for leave to present Horwitz's testimony by telephone.54 Indeed, throughout this proceeding, counsel for complainants has made it clear that she was relying on Horwitz as an expert. As noted above, counsel submitted a one-page summary of Horwitz's qualifications, licenses and experience along with the Report disclosing his opinions. Moreover, in her post hearing submission, complainants' counsel described the Report as "[t]he strongest evidence" that the account statements RB&H provided were deceptive.
As a consequence of the ALJ's failure to address counsel's motion, respondents were denied an opportunity to cross-examine Horwitz. Such cross-examination plays a vital role in a decisionmaker's reasoned assessment of the reliability of opinions expressed by experts.55 Consequently, the record lacks an adequate basis for assessing the weight properly accorded to the Horwitz Report, the attached schedules, or the related documents. In these circumstances, we strike these documents from the evidentiary record.
Finally, we conclude that the ALJ erred by failing to assess the reliability of McDaniel's version of the events at issue in light of the record as a whole. Compare Secrest v. Madda Trading Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,627 (CFTC Sept. 14, 1989) (the ALJ's failure to explain his assessment of the conflicting evidence suggested that he may not have properly evaluated the reliability of the evidence underlying his factual conclusions). For example, the ALJ discussed and credited some of the more consistent elements of McDaniel's version of events. These included claims that: (1) Price touted his strategy as conservative but successful, and referred to it as the best kept secret in the industry; (2) trading under Price's strategy was initially successful, and this success led McDaniel to urge others to open accounts with Price; (3) Price implemented his strategy in an incompetent manner that failed to protect the accounts from risk; (4) Gorrie failed to properly supervise Price's use of the strategy; and (5) she was unaware of losses in the account until Patricia Bragg told her that Price's trading had resulted in the loss of her entire account.
The ALJ also discussed and credited McDaniel's self-portrait as a naļve and trusting trader who was unable to understand either Price's trading strategy or the account statements provided by RB&H.56 The ALJ did acknowledge two facts that are arguably incompatible with this portrait - McDaniel's training in futures trading and her experience trading through another FCM. Nevertheless, he failed to even mention several other relevant circumstances including: (1) McDaniel's written claim that she instructed Price to diversify the accounts' trading into commodities other than the dollar index; (2) McDaniel's written claim that she instructed Price to begin liquidating all positions in the account; (3) McDaniel's written claim that she implored Price to liquidate positions with an accrued profit more quickly; (4) McDaniel's written claim that she became disenchanted with Price's increasing lack of ability and confidence; and (5) McDaniel's testimony that she understood how options trading in securities worked. All of these claims, which McDaniel either verified at the hearing or in a written submission to the Commission, are somewhat inconsistent with McDaniel's self-portrait.
Even apart from these facially inconsistent claims, McDaniel's version of events is marred by her unexplained abandonment of aspects of her deception claim including: (1) her claim that Price first assured her that the accounts would gain 90 percent before Christmas and then retreated to a prediction of a 60 percent gain by Christmas; and (2) her claim that Price touted his trading strategy as successful without disclosing that several of his customers had suffered significant losses while using his trading strategy. McDaniel did not address these claims in her testimony. Certainly it is not unusual for parties to adjust the focus of their cases during the course of a proceeding in order to emphasize some claims over others. The unexplained abandonment of this type of specific and compelling claim, however, raises questions about McDaniel's sincerity when she initially raised them.
Most disturbing, however, is the stark contrast between McDaniel's claim that Price's trading was successful for a substantial period of time and the performance disclosed on the monthly account statements that RB&H provided. As noted above, a review of the monthly account statements for the two trusts shows that in no instance did the account value at market equal or exceed the amount of funds then invested. The best month for the Miner trust account (June) showed an account value at market three percent lower than the amount deposited. The best month for the Family trust account (June) showed an account value at market 23 percent lower than the amount deposited. These figures raise significant questions about McDaniel's testimony that she invested additional funds in the accounts because "they were doing so well." (Tr. at 57, 63.)
These figures also raise serious questions about McDaniel's claims that she did not realize that the accounts were in trouble until January 1997. The account value at market disclosed in the account statements show that both accounts had accrued losses in excess of 50 percent of the funds deposited by the end of July. While the amended complaints claimed that Price misrepresented the trading results when they deteriorated, McDaniel offered no testimony in support of this claim at the hearing. Given the results disclosed by RB&H in the monthly account statements, McDaniel's claim that she maintained the accounts in the belief that Price's strategy posed no risk is facially incredible.
McDaniel's testimony does not address the information reflected on the account statements. As noted above however, one of her written statements does claim that she and her husband were unable to "totally comprehend" the complexity of the account statements. Moreover, on appeal, complainants claim that Price and Gorrie's own testimony show that the account statements were sufficiently confusing to mislead McDaniel. The record, however, suggests that Price and Gorrie were confused about how RB&H may have calculated some of the figures disclosed on the account statements. Such confusion has nothing to do with the task confronting McDaniel - noting the last figure on the monthly account statement and recognizing that it indicated the trusts' accounts were generally accruing substantial losses. As our description in the background shows, the monthly account statements clearly disclosed figures that permitted McDaniel to accurately evaluate the success of Price's trading. The record does not support a finding that this disclosure was either deceptive or confusing.
The record does not show that McDaniel was as sophisticated as respondents have suggested throughout this proceeding. Moreover, Price's evasive testimony about when he advised McDaniel that his strategy was not performing well raises significant questions about the character of his ongoing advice to McDaniel. It is undisputed, however, that McDaniel had traded a futures account at another FCM prior to opening the trust accounts with RB&H. McDaniel also had experience trading securities and had taken a futures-trading course and paper traded "for months." These circumstances make it difficult to believe that McDaniel was sufficiently unsophisticated to be unable to recognize the significance of a figure the account statements clearly described as the "account value at market."57
Some of the information disclosed by the account statements is consistent with McDaniel's version of events. The account statements consistently disclosed that both accounts had a high cash balance.58 If McDaniel had been focusing on the cash balance as the proper measure of trading success, she might have believed that trading was doing well between July and September. The account statements, however, accurately disclosed the value of the accounts at market and there is no evidence that respondents' conduct led McDaniel to focus solely on the cash balance. Indeed, during this entire proceeding McDaniel never mentioned the cash balance disclosed on the trusts' account statements.59
McDaniel's decision to recommend that friends open accounts with Price is also consistent with her version of events. The record, however, does not disclose either precisely when McDaniel made her recommendations or what she said to convince her friends to invest. On this record, we can only speculate about possible rationales for recommending Price's trading strategy to others.
The record as a whole simply raises too many doubts about the overall reliability of McDaniel's version of events. Indeed, neither complainants' nor respondents' version of the events that led to the trusts' losses is sufficiently reliable to permit findings supported by the weight of the evidence. In such circumstances, complainants, as the party with the burden of proof, cannot prevail.60
As a matter of future guidance, we briefly address respondents' challenge to the ALJ's findings regarding churning. While the record includes a number of confusing references to churning, the amended complaint clearly did not raise a churning claim. Such a claim was implicit in one element of the analysis in the Horwitz Report, but counsel for complainants never sought to amend the amended complaint to add a churning claim and respondents' conduct at the hearing did not manifest consent to the litigation of such a claim.61
Because the parties did not litigate a churning claim, the ALJ did not have a proper basis for making findings that were solely material to such a claim. Including them in his decision amounted to an abuse of discretion, and the abuse was not cured by his refusal to rely on the findings as a basis for his damage award. Indeed, in other circumstances we might view such conduct as evidence of the type of "deep-seated favoritism or antagonism" that requires disqualification. Compare Nikkhah, ¶ 28,129 at 49,883. In the circumstances of this case, it is sufficient that we strike the ALJ's findings concerning churning from the record.
In light of the foregoing, we vacate the ALJ's decision and dismiss the complaints for a failure of proof.
IT IS SO ORDERED.62
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 26, 2000
1 The named respondents played varying roles in the events at issue in these cases. We use the term "respondents" to refer to all the appealing parties and otherwise refer to each individual respondent by name.
2 Respondent Price testified about certain conversations with Charles McDaniel, but Price's contact with McDaniel's husband was clearly secondary to his contact with McDaniel.
3 During the time at issue, Tradeline was registered as an introducing broker ("IB") and RB&H was registered as a futures commission merchant ("FCM"). RB&H entered an agreement with Tradeline to guarantee its obligations under the Commodity Exchange Act ("Act"). Both respondents Price and Gorrie were registered associated persons ("APs") sponsored by Tradeline. Gorrie's duties as president of Tradeline included supervision of account executives, including Price.
4 At the time McDaniel filed the trust-complainants' claims with the Commission, she attached a copy of the account statements that RB&H had provided to her during the period the accounts were open. Our description of the trading in the accounts and the results of the trading is drawn from the information disclosed by these statements.
5 The CFTC Glossary defines a strangle as an option position consisting of the purchase or sale of put and call options having the same expiration but different strike prices. For ease of reference, we sometimes refer to the trust accounts' trading in U.S. dollar index options as trading in strangle positions. As discussed more fully below, at the hearing Price referred to the strategy he followed as a "delta neutral options strategy."
6 These categories included: (1) current account balance segregated U.S. dollars (representing the account's cash balance), (2) total open trade equity (representing the accrued value of open futures positions), (3) net market value of options (representing the accrued value of open option positions), and (4) account value at market (representing the value of the account if all open positions had been liquidated as of the end of the day).
7 These included: (1) initial margin requirement, (2) maintenance margin requirement, and either (3) excess equity (representing funds that might be used to margin additional trades) or (4) margin deficit (representing funds that must be submitted to maintain the current positions).
8 McDaniel had deposited an additional $15,000 to the account that day.
9 Dollar amounts in parentheses are negative.
10 The categories reflecting aspects of the month-end account value were similar to those in the daily account statements: (1) current account balance segregated U.S. dollars (representing the account's cash balance), (2) total open trade equity (representing the accrued value of open futures positions), (3) total option market value of options (representing the accrued value of open option positions), and (4) account value at market (representing the value of the account if all open positions had been liquidated as of the end of the month).
11 These included: (1) net futures profit or loss, (2) net option premium for month, and (3) realized option memo P&L.
12 The monthly account statements show that McDaniel invested a total of $57,000 in the Family trust account, and over $31,000 in the Miner trust account.
13 McDaniel's daughter-in-law Linda was among a group of friends and relatives that McDaniel had urged to open an account at Tradeline.
14 McDaniel did, however, state that she was responsible for a "very few" of the losing trades in the Miner trust account. As noted above, she also acknowledged instructing Price both to diversify the contracts he traded and pull back from trading in December 1997. In this regard, McDaniel claimed that she had become "disenchanted with [Price's] increasing lack of ability and confidence." Finally, McDaniel stated that she always "implored" Price not to remain in profitable contracts but "to take our profits, be happy, and get out!"
15 McDaniel offered a varied response to the allegations underlying respondents' accord and satisfaction defense. She admitted that she told respondent Gorrie that she would refrain from further claims for the losses that the trust had suffered, but emphasized that she wasn't speaking for the beneficiaries of the trust accounts. She also admitted that she later changed her mind and "went back on [her] word." McDaniel, explained, however, that during their conversation, Gorrie had told her that nothing she said or did had anything to do with his decision to reinstate her daughter-in-law's Tradeline account.
16 The Office of Proceedings apparently regarded each complaint as an independent matter because, despite the common role that McDaniel played as trustee, the Family trust and the Miner trust is each a distinct legal entity. Under the Commission's reparation rules, only complaints seeking damages in excess of $30,000 are eligible for a formal decisional proceeding, where parties are generally entitled to an in person rather than a telephonic hearing on disputed issues of fact. The Family trust's complaint met this threshold, but the Miner trust's complaint only sought $28,000 in damages. Consequently, the Miner trust's complaint could not be forwarded for resolution in a formal proceeding.
17 We note, however, that we expect counsel for parties in reparations cases to deal with pro se parties in a manner consistent with their ethical obligations. In appropriate circumstances, evidence that counsel knowingly misled a pro se party about her rights or obligations under the Commission's reparations rules could be a basis for imposing sanctions under Commission Rule 14.8(c).
18 Respondents also sought information and documents about the trust complainants, such as the nature of the two trusts, limitations the trust agreements imposed on the trustees' authority to make investments, and the trusts' investments and financial condition during the preceding five years.
19 Commission Rule 12.30(b)(1) provides that discovery is limited to unprivileged material that is relevant to the subject matter of the pending proceeding. Subsection (2) authorizes presiding officers to issue orders that protect a party from annoyance, embarrassment, oppression, or undue burden or expense.
20 The ALJ had not ruled on respondents' motion to compel by the deadline for submitting a prehearing memorandum. Consequently, respondents' submission was brief and general. It emphasized that a more detailed response would have to await the judge's resolution of the motion to compel. Complainants' memorandum urged the ALJ to schedule a hearing as soon as possible and complained that respondents were needlessly delaying the proceeding by making unnecessary, overbearing demands for irrelevant and voluminous documentation. McDaniel claimed that the trusts' investment objectives were to "make money and avoid margin calls" and that the loss of all the funds in both accounts was inconsistent with these objectives. The statement summarized the alleged wrongdoing as (1) Price's misrepresentation of his ability and the safety of his trading strategy; (2) Price's failure to disclose that his clients had previously suffered losses using his strategy; and (3) Price's ill advised, incompetent and poorly monitored trading of the accounts.
21 This ruling was discussed at the hearing. See note 27, infra. Because this conference was not recorded, we cannot determine either the subjects that were discussed or the basis for any rulings that the ALJ made during the conference. There is a memorandum in the file purporting to summarize the discussions, but it is sketchy, at best, and fails to reflect any discussion of respondents' use of McDaniel's deposition.
In our experience, such off-the-record conferences have become an impediment to meaningful review of certain rulings by presiding officers. Consequently, we direct presiding officers to record all telephone discussions conducted with counsel for parties to a proceeding that relate to any issue that may become the subject of an appeal to the Commission in that proceeding. When a presiding officer determines that such a conversation need not be recorded, he shall make a written finding on the record that the sole subject discussed during the conversation was settlement of the dispute at issue in the proceeding or a specified issue that will not be the subject of an appeal before the Commission. The tape recording of a covered conversation shall be delivered to the Proceedings Clerk and maintained in the official record of the proceeding.
22 The ALJ never explained how these documents were relevant to any of the alleged wrongdoing McDaniel had described in her written submissions. Nevertheless, he insisted that respondents submit the specified documents even after he was notified that counsel for complainants had advised counsel for respondents that she did not need the documents for complainants' case. While respondents eventually submitted the documents specified by the judge, they apparently played no role in the ALJ's decision in this matter.
23 Respondents chose not to file an amended answer.
24 Cf. Boring v. Apache Trading Co., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,380 at 39,282 (CFTC Aug. 27, 1992) ("[A]n ALJ abuses his discretion if, in the absence of special circumstances established on the record, he permits a party to substitute an affidavit (or similar hearsay declaration) for oral testimony on material issues of fact.")
25 Counsel did not specify the documents she had sought from respondents nor did she explain why the information disclosed in the account statements that McDaniel had submitted with the complaints was insufficient to calculate the trusts' losses. Experts rarely appear in reparation proceedings to testify about damage calculations.
26 When monthly commission-to-equity ratios are calculated in the context of an excessive trading analysis, commissions and fees are only included if the evidence establishes that the trade at issue was the product of the control exercised by a customer's account executive. As noted above, earlier in the proceeding, McDaniel had acknowledged that she was responsible for some of the trades in both accounts.
27 In this regard, the judge explained that:
I hear a lot of noise about expert witnesses. And I - like the idea of having very intelligent people make sense out of what could be rather confusing material. I see all - there's not a thing here that could not be included in a brief filed by [counsel for complainants], I assume.
(Tr. at 83.)
28 Both the ALJ and counsel for complainants agreed that this issue had come up at the unrecorded December 3 telephone conference. The ALJ indicated that he had ruled that "we don't take these things." Id.
29 McDaniel explained that:
[B]ecause these markets move so fast you have to be sitting in front of the screen watching them and monitoring them constantly and knowing what you're doing. There is no way I could have possibly done that. That's why I had a broker.
(Tr. at 66.)
30 McDaniel insisted that this representation amounted to a guarantee that the trust accounts would not lose money following Price's strategy. (Tr. at 72.)
31 Counsel for respondents asked McDaniel several questions about her phone conversation with respondent Gorrie after she transferred the trust accounts from Tradeline. She acknowledged that she told Gorrie that she would "forget it and walk away" if Gorrie "restored Linda [McDaniel]'s account." (Tr. at 132.) McDaniel also confirmed that Gorrie returned money to Linda McDaniel's account. (Tr. at 133.) McDaniel insisted, however, that she did not understand either "what happened in [the trusts' accounts or] why" at the time she spoke to Gorrie. Indeed, McDaniel testified that "[t]o this day, I don't think I understand what happened in [the trust accounts] nor why." (Tr. at 133.)
32 Price acknowledged that the trust accounts received several margin calls and attributed them to increased margin levels and market volatility. (Tr. at 38.) He testified that he advised McDaniel that she could liquidate positions, change some positions, or add money to the accounts in response to the calls. (Tr. at 40.) He recalled that she sometimes added additional funds, but that on most occasions they reduced positions. He also noted that on a couple of occasions "the market took us off margin call." (Tr. at 38.)
33 Much of Gorrie's testimony focused on respondents' accord and satisfaction defense. Gorrie recalled that he telephoned McDaniel after he received her March 5, 1997 faxed letter alleging various claims against respondents. During this conversation, Gorrie testified that complainant told him she would not pursue claims against respondents if he restored Linda McDaniel's initial investment. According to Gorrie, he duly deposited $5,600 into Linda McDaniel's account the day after this telephone conversation took place. (Tr. 118.) Gorrie thought that the parties had reached a mutual accord and satisfaction until he was served with the reparations complaints. (Id.) Gorrie testified that he was shocked and on June 11, 1997 telephoned complainant to inquire. According to Gorrie, complainant admitted during this conversation that she "had lied to him" by her decision to repudiate their previous agreement because she could not afford to sustain losses amounting to $90,000 in the two accounts. (Id. at 118-119.)
34 Gorrie said that SPAN requirements were computer generated based primarily on volatility and standard deviation. (Tr. at 108.)
35 Account statements submitted by complainants showed that on February 21, 1998 a check for $37,134.14 was issued from the Family trust account and a check for $52,679.91 was issued from the Miner trust account. The record does not show the value of the open positions that the trusts transferred to their new FCM.
36 Complainants' post-hearing submissions argued that Price deceived McDaniel by guaranteeing that she would earn profits by following his strategy and failing to disclose the strategy's risks. Complainants also argued that Price's and Gorrie's confusing testimony supported McDaniel's claim that respondents failed to provide accurate information about the status of the trust accounts. Complainants relied heavily on the Horwitz Report, characterizing it as "[t]he strongest evidence of respondents' misrepresentations and omissions regarding the status" of the trust accounts. Complainants' Post-Hearing Brief at 8. In this regard, they emphasized Horwitz's conclusions that: (1) the account statements overstated the amount of excess equity; (2) if margins had been properly calculated, the trading leading to the accounts' great losses could not have taken place; and (3) Price's trading strategy guaranteed excessive commissions for respondents without affording complainants a reasonable possibility of profit.
37 Respondents' post-hearing submissions claimed that McDaniel's own testimony confirmed their claim that she entered into a binding settlement of the disputes underlying these reparation claims. Respondents also noted apparent contradictions in McDaniel's version of events as well as her unexplained interpretation of an alleged comment about the best kept secret in the industry as a guarantee of profit. They emphasized that McDaniel was in contact with Price on a daily basis and received information from neutral sources about delta neutral options trading as well as account statements that accurately disclosed the status of the trust accounts.
38 The ALJ severely criticized Gorrie's testimony about the amount of money that was sent to the new FCM when the trust accounts were transferred in February 1998. In this regard, he concluded that:
It is appalling that the president of Tradeline and the supervisor of Price would testify under oath that some $87,000 was paid out to the accounts, when in fact that pay out was under $800. Gorrie was named as a respondent in this case in 1997, and his testimony suggests that he was either careless or indifferent in preparing for trial, or that he is not concerned with determining the truth.
I.D. at 46,913.
39 The ALJ included frequent references to facts that he viewed as supporting a finding that the goal of respondents' allegedly deceptive conduct was generation of commission income. For example, he found that McDaniel deposited $57,000 into the Family trust account and paid over $32,000 in commissions. He found that McDaniel deposited $31,215 into the Miner trust account and paid over $17,000 in commissions. The judge found that the Family trust account had an average commission-to-equity ratio of 15.44 percent per month with a high of 24.87 percent. The judge found that the Miner trust account had an average commission-to-equity ratio of 11.43 percent per month with a high of 21 percent. The ALJ indicated that these findings were based on the Horwitz Report, but noted that the account statements "confirmed" the Horwitz calculations. I.D. at 46,913. The ALJ eventually noted that there was a "wealth of evidence" to show that the accounts were churned to generate commissions, but held that it was unnecessary to do a churning analysis because complainants prevailed on other theories of fraud. I.D. at 46,914.
40 The judge provided examples from a statement dated May 31, 1996 and a statement dated June 7, 1996.
41 The ALJ provided examples from a statement dated July 10, 1996 and a statement dated October 21, 1996.
42 In support of his finding that McDaniel was misled, the ALJ claimed that McDaniel had testified that the account statements were so confusing that she did not learn that the accounts were losing money until Patricia Bragg called to tell her that Bragg's account had been wiped out. I.D. at 46,913 citing Tr. 48-50. As discussed infra, the record is to the contrary.
The ALJ acknowledged that respondents had submitted the letter from the CME addressing the margin status of the accounts in January and February, but concluded it did not rebut the charts and summaries in the Horwitz Report. He stated that the letter "is of little or no value in deciding the issues in this case." I.D. at 46,913-14.
43 The ALJ rejected respondents' accord and satisfaction defense as unsupported by the record. The judge acknowledged that McDaniel's testimony supported Gorrie's claim that McDaniel agreed to drop any complaint against respondents provided Gorrie would "`Restore the equity in Linda McDaniel's account.'" I.D. at 46,913. Nevertheless, he concluded that the purported agreement "does not bar the filing of [the trust accounts'] complaints" because "at the time of this oral agreement, McDaniel was totally unaware of the practices respondents employed in the trading of the accounts at issue." Id.
44 It also challenged the ALJ's rulings relating to McDaniel's deposition, claiming that there was no basis for prohibiting respondents from either introducing the admissions in the deposition as evidence or using them to refresh McDaniel's recollection during cross-examination.
45 It also argued that the ALJ had: (1) misread critical aspects of Gorrie's testimony; (2) ignored documentary evidence establishing that McDaniel was aware of the nature of the trusts' claims when she agreed to forfeit the claims in return for reinstatement of Linda McDaniel's account; and (3) awarded damages for losses unrelated to the trades that Price recommended under his options strategy.
46 It argued that the ALJ's restrictions on respondents' use of McDaniel's deposition were appropriate because any admissions it contained were made in the course of settlement negotiations.
47 The brief also argued that the ALJ's dismissal of respondents' accord and satisfaction defense was appropriate because the record showed that the communications regarding settlement were ambiguous and that McDaniel did not fully understand the nature of the trusts' claims when she spoke to Gorrie. As to damages, complainants' brief emphasized that the ALJ thoroughly considered all the evidence and that the amount was fair and reasonable in light of complainants' unrefuted damage calculations.
48 As noted above, complainants argue that the ALJ's error was harmless because respondents obtained information about McDaniel's sophistication and trading experience when their counsel deposed her. The ALJ, however, prevented respondents from using the deposition at the hearing, a ruling that complainants support on appeal. Moreover, there is no indication that McDaniel provided respondents with relevant documents at the time of her deposition. In these circumstances, the record does not support complainants' harmless error analysis.
49 The ALJ erred by ruling that there is no legitimate use for depositions in reparation proceedings. Cf. In re Nikkhah, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 28,129 at 49,883 (CFTC May 12, 2000) (in appropriate circumstances, admissions made in an investigatory deposition admissible as evidence). Complainants, however, contend that the admissions in the deposition should be excluded because they were made in the context of settlement discussions. Given our conclusion on the merits, we need not resolve this aspect of the parties' dispute.
50 In this regard, Horwitz opined that RB&H was calculating excess equity by subtracting the relevant margin requirement for each trust account from that account's cash balance. This aspect of Horwitz's opinion is not consistent with the account statements in the record. The December 27 account statement for the Family trust account indicated that the cash balance was $48,281.29 and the excess equity was $6,946.29. Under Horwitz's view, the cash value -- $48,281.29 -- minus the margin requirement should equal the disclosed but allegedly deceptive amount of excess equity -- $6,946.29. For this to be true, the margin requirement must be $41,335. In fact, neither of the two margin figures disclosed by the account statement ($40,075 (initial margin) $36,947.60 (maintenance margin)) match this number. Similarly, the figures disclosed by the December 26 account statement for the Miner trust account are also inconsistent with Horwitz's theory.
51 The ALJ made a similar error when he found that the figures disclosed in the account statements confirmed Horwitz's calculation of the trust accounts' monthly commission-to-equity ratios. Such ratios are used to assess whether trading activity controlled by an account executive was sufficiently excessive to raise an inference that he was trading to generate commissions. Consequently, the first task for an expert calculating these ratios is assessing the circumstances relevant to determining the trades controlled by the account executive. For example, Horwitz's calculation of monthly commission-to-equity ratios in this case apparently rests on his implicit judgment that Price controlled all the trading in both of the trusts' accounts. None of the figures disclosed in RB&H's account statements provide a basis for assessing the reliability of this aspect of Horowitz's opinion. In any case, Horwitz's implicit judgment cannot be squared with either McDaniel's admission that she was responsible for some of the trades in the Miner trust account or her statements about insisting that Price diversify trading in the account beyond U.S. dollar index options.
52 We take official notice of the current Margin Handbook issued by the Joint Audit Committee in 1999 ("1999 Margin Handbook") which clearly indicates that FCMs using SPAN may employ one of two different methods to compute the funds available to margin a customer's trades. 1999 Margin Handbook at 4-2 to 4-3. While the account statements at issue here were prepared in 1996 and Horwitz's analysis was prepared in 1998, the information in the 1999 Margin Handbook illustrates the importance of evaluating the implicit presumptions underlying an expert's conclusions.
53 Both complainants and the ALJ criticize the conclusory analysis in the CME letter submitted by respondents. We do not imply that the view expressed in the letter is facially more reliable than that expressed in the Horwitz report.
Nevertheless, because complainants must establish the reliability of Horwitz's analysis in order to prove that RB&H's disclosure of the trust accounts' excess equity was deceptive, it is sufficient that the CME's letter raises a substantial question about Horwitz's implicit claim that he knew and applied the only legitimate method for calculating excess equity.
54 Given the belated nature of counsel's request, her weak explanation of the need for expert testimony, and respondents' objection to Horwitz's appearing by telephone, the appropriate ruling would have been to deny the motion.
55 Providing respondent an opportunity to submit a statement in rebuttal is not an adequate substitute for an opportunity to cross-examine an expert about either the bases for his judgments or his qualifications to offer such judgments. Moreover, even when the judge is convinced that he has sufficient expertise to resolve all material issues without the benefit of expert analysis, the parties should be given the opportunity to build an appropriate record.
56 As noted above, the ALJ indicated that McDaniel had testified that the account statements were confusing. I.D. at 46,913 citing Tr. at 48-50. The cited pages do not include any testimony about RB&H's account statements. Indeed, as noted below, McDaniel did not address the account statements in her testimony.
57 Moreover, as noted above, McDaniel claimed that she implored Price to liquidate positions with an accrued profit more quickly. This suggests that she was following how long profitable positions were left open. A customer would generally use account statements to track this information.
58 In the Miner trust account, the amount of the cash balance always exceeded the amount of funds deposited. The percentages that the cash balance exceeded the funds deposited ranged from 24 to 118 percent. The situation in the Family trust account was more mixed. Between April and September, the amount of the cash balance exceeded the amount of funds deposited by between 10 to 50 percent. Between October and December, however, the amount of the cash balance was less than the amount of the funds deposited by between 11 and 19 percent. In January, the amount of the cash balance exceeded the amount of funds deposited by about 45 percent.
Option sales tend to inflate an account's cash balance because the full premium is received at the time an option is sold. These premiums may only be retained, however, if the underlying market does not reach the option's strike price. Consequently, when an account sells a significant number of options, the cash balance is not an appropriate basis for assessing the success of the account's trading.
59 Indeed, McDaniel also never testified that she was misled by what the ALJ erroneously found to be RB&H's deceptive disclosure of the trust accounts' excess equity.
60 Given the outcome of our analysis, we need not consider respondents' contentions regarding the ALJ's assessment of the evidence relating to damages or its accord and satisfaction defense. We note, however, that there is no basis in the record to infer that deception concerning Price's U.S. dollar index option trading strategy was the proximate cause of losses resulting from trades in other futures or options contracts.
61 Commission Rule 12.307(c) recognizes that issues tried with the express or implied consent of the parties should be treated "in all respects as if they had been raised in the pleadings."
62 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 and that any appeal is not effective unless, within 30 days of the date of the Commission order, the appealing party files with the court a bond equal to double the amount of any reparation award.