UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
JOSEPH M. and VIRGINIA S.
CFTC Docket No. 97-R116
JAMES ARTHUR BRADFORD, THE
GROUP, INC., IOWA GRAIN COMPANY, and
PERRY GARTH WILSON
JOSEPH M. and ROSE MARIE
|CFTC Docket No. 97-R117|
JAMES ARTHUR BRADFORD, THE
GROUP, INC., IOWA GRAIN COMPANY, and
PERRY GARTH WILSON
|OPINION AND ORDER|
Respondents James Arthur Bradford ("Bradford"), The Hampton Group, Inc. ("Hampton Group"), Iowa Grain Company ("Iowa Grain") and Perry Garth Wilson ("Wilson") appeal from the decision of an Administrative Law Judge ("ALJ") awarding complainants James, Virginia, and Rose Marie McGough $183,203.86 plus interest.1 Respondents raise procedural, factual, and legal challenges to the ALJ's decision. Complainants move to strike several of respondents' appellate submissions and, on the merits, urge the Commission to affirm all aspects of the ALJ's decision.
For the reasons that follow, we conclude that the ALJ
erred in several respects. In light of our independent review of the record, we
conclude that respondents Bradford and the Hampton Group violated Section 4b(a) of the
Commodity Exchange Act ("Act") and Commission Rule 4.41(b) by failing to
disclose that the successful track record that Bradford used to promote Wilson's
trading system to McGough was partially based on hypothetical trading results. We
conclude that Bradford, the Hampton Group, and Iowa Grain are responsible for the
$94,298.24 in damages proximately caused by these violations. We vacate the ALJ's
conclusions as to respondent Wilson due to a failure of proof, but reject Wilson's
jurisdictional challenge and remand for further proceedings on a claim that Wilson
aided and abetted the other respondents' wrongdoing.
McGough is a retired nuclear engineer with some experience trading futures. He opened the two accounts at issue in this proceeding in March and June of 1995.
The Hampton Group was a guaranteed introducing broker ("IB") based in Laguna Beach, California. It ceased doing business and withdrew from registration with the National Futures Association ("NFA") several months before the complaints in this proceeding were filed. Bradford was an associated person ("AP") sponsored by the Hampton Group. Although he did not solicit McGough to open his accounts, Bradford served as complainants' account executive during the period at issue in this proceeding.
Iowa Grain was a futures commission merchant ("FCM"). It carried and cleared the trades that McGough entered through the Hampton Group. It entered into an agreement to guarantee the Hampton Group's obligations under the Act that was effective from September 1994 through February 1997.
Wilson was a customer of the Hampton Group. After the events at issue in this case, he became registered as a commodity trading advisor ("CTA"). Unlike the other respondents, Wilson neither answered the complaint nor appeared at the hearing. Consequently, the precise role he played in the events at issue is uncertain.
McGough, acting pro se, filed two substantially identical reparations complaints in August 1997.2 Each complaint sought damages for the losses sustained in one of the two accounts McGough maintained at Iowa Grain. McGough used the same narrative description of events in both complaints. In general, McGough alleged that "Bradford and the Hampton Group misrepresented the accuracy and profitability of the trading system being touted by Dr. Perry G. Wilson, failed to disclose the substantial risks associated with commodity trading . . . and . . . engaged in unauthorized trading against my express wishes." Id. at ¶ 18.
McGough said that he opened his first account with the Hampton Group in March 1995, depositing $50,000. McGough explained in subsequent pleadings that this account was opened at the solicitation of Brad Busby, an account executive with the firm.3 McGough followed Busby's recommendation to make a one-contract Treasury bond trade and incurred a small loss. McGough then ceased trading. In mid-April, Bradford called McGough and reported that he would now be handling McGough's account because Busby had left the firm.
McGough alleged that Bradford said he had a customer, a Dr. Perry Wilson, who "was doing extremely well in trading the S&P futures contract." According to McGough, Bradford told him he intended to use Wilson's system to trade several accounts and invited McGough to participate. Complaint Narrative at ¶ 2. McGough agreed that he would deposit another $50,000 to his account if following Wilson's strategy produced a $10,000 profit. Id.
McGough began trading his account based on Bradford's interpretation of Wilson's strategy in mid-April 1995.4 McGough initially traded S&P 500 options and futures.5 By May 1, the value of McGough's account had increased by almost $10,000.6 Consistent with his agreement with Bradford, McGough deposited another $50,000, raising his total deposit to $100,000. McGough continued to trade S&P 500 options and futures during May, and toward the middle of the month began entering Eurodollar option positions.7
In mid June, McGough opened a second account, depositing $100,000. McGough traded S&P and Eurodollar positions in both accounts that month but there were differences in the type and number of positions established in each account.8
Alleged Unauthorized Trading
McGough's complaints alleged that all trading in both
accounts after July 6 was unauthorized:
From July 6, thru July 22, 1995 my wife and I, daughter, son-in-law and grandchildren went on vacation . . . . Bradford was advised of this and instructed not to trade unless I called in and OK'd the trade. I did not call in because the cabins we were in did not have telephones and I had no means of monitoring the market.
Complaint Narrative at ¶ 9.9 He further alleged that upon his return, he advised Bradford that he would not trade until early August because he had houseguests and had no time to follow the markets.
According to the complaints, McGough did not learn that Bradford had made a substantial number of losing trades in his absence until he reviewed his account statements after retrieving his accumulated mail from the post office. Id. at ¶ 11. McGough claimed that when he protested respondents' failure to follow his instructions, Bradford replied that McGough "had to follow the doctor's system if he expected to make any money." Id. at ¶ 12. McGough alleged that respondents continued to trade the account in August despite his specific instruction that neither account be traded until further notice. Id. According to the complaints, respondents did not cease trading until McGough called Bradford and demanded that he "close both accounts and send [McGough] the proceeds." Id. at ¶ 13.10
Written Representations About Wilson's Trading Strategy
Eight faxes that McGough allegedly received from Bradford
were attached to the complaints. According to McGough, these faxes reflected
Wilson's trading instructions to Bradford on various days in April, May and June
1995. The April 27, 1995 fax included comments about Wilson's trading system's
recent track record:
Although there haven't been any losses in April yet, the track record since Jan. 1, 1995 is 13 wins, 4 losses (76% are winners), ave. win $1050, ave. loss 1062.50 (win/loss ratio -- 1.74). Net profit after deducting commissions is $19,205 since Jan. 1. From the time I began paper trading this system in real time (Oct. 25/94 to the end of 1994) the profit was $18,605. Therefore the total profit in 5 months is $37,810 after deducting commissions.
(Emphasis in the original.) Another fax included these
Day orders for Perry Wilson for 5/23/95:
1. If June Eurodollars hit 93.92 or higher, sell 3 June Eurodollar 93.73 calls to close a position @ market, OCO order #2.
Six similarly numbered orders follow, followed by a
comment about the market movements anticipated by Wilson's trading
Jim, my system is calling for a brief pull back Tues. Then renewed upward movement Wed. & beyond. . . .
Iowa Grain, the Hampton Group, and Bradford submitted a joint answer. They not only denied that they had executed unauthorized trades in McGough's account, they also denied that McGough had ever complained to Bradford about alleged unauthorized trades. As for the allegations relating to representations about Wilson's trading strategy, respondents insisted that McGough knew that the information that Bradford provided about Wilson's Eurodollar trading "represented hypothetical trading results." Ans. at 3. Respondents also emphasized McGough's role in trading the accounts, noting that while McGough occasionally declined a recommendation or traded less than the recommended number of contracts, "on many occasions . . . [McGough] increased the number of contracts." Id. at 2.
Respondents asserted several affirmative defenses. First, they argued that the complaints were untimely because they were not filed within two years of the complained-of wrongdoing. They also asserted defenses of waiver, ratification, estoppel, and failure to mitigate damages.11
Respondent Wilson only offered an informal, unsworn response to the complaints. His letter to the Director of the Office of Proceedings generally addressed the complaints' substantive allegations and advised that:
[D]uring the time frame in question (April through August
1995), I was not registered as a CTA. I was a client of The Hampton Group. I faxed my
orders to them for execution. If another of their clients was placing orders which
mimicked mine, that occurred without my knowledge, and I certainly received no
compensation in any form for anyone else's use of the orders I was faxing in for
my own personal trading. In fact, my trading system turned sour in July and August of
1995, with the result that I personally lost a large amount of money.
I will not be wasting any more of my time responding to any more of these complainants' frivolous allegations.
Letter from Perry G. Wilson (received October 31, 1995). The Office of Proceedings responded with a letter advising Wilson that his submission was deficient as an answer under the Commission's reparations rules.
Proceedings Before the ALJ Relating to Discovery
Both cases were forwarded to the same ALJ for adjudication. On November 26, 1997, the judge issued a prehearing order that established a schedule for commencing and completing discovery. Iowa Grain served interrogatories and requests for production of documents on McGough. Among other things, Iowa Grain sought (1) information about McGough's vacation itinerary during July, (2) telephone records reflecting any calls made while he was vacationing, and (3) "any other documentary evidence to support [McGough's] contention that [he was] out of town and otherwise unavailable to speak or communicate with any of the [r]espondents from July 6 through July 22, 1995."
McGough in turn served his own discovery requests on respondents. Among other things, he sought information about (1) their use of Wilson's trading system to guide trading in other clients' accounts, and (2) the remuneration that they provided to Wilson in exchange for his permission to use his trading system in this manner.12
Respondents refused to supply detailed information about their use of Wilson's trading system to guide trading for other clients. Iowa Grain did acknowledge that both Bradford and another associated person with the Hampton Group used Wilson's recommendations to guide trading for other clients. It refused, however, to name the clients, specify how many clients were involved, describe the nature of their trading, or disclose the results of their trading. Respondents insisted that they had not compensated Wilson for their use of his trading system.
McGough was equally evasive in his response to respondents' inquiries about his telephone contacts during his vacation. He reiterated his claim that neither he nor his wife "had any conversations via telephone, facsimile or otherwise with any of the [r]espondents while on vacation from July 7, 1995 until our return on July 19, 1995." He refused, however, to provide relevant telephone records, characterizing the request as "overbroad, burdensome and oppressive," and an invasion of his right to privacy. Indeed, he waited until after the ALJ had overruled his objection and granted respondents' motion to compel production to reveal that he had no relevant records because "all telephone calls made to Bradford were pursuant to an "800" number, provided by the [r]espondents." (Supplemental Response to Discovery, filed Mar. 20, 1998.)
The Parties' Prehearing Memoranda13
McGough's first prehearing memorandum, submitted on March 2, 1998, identified several issues to be resolved: (1) whether respondents had misrepresented (a) "the nature and success of Wilson's trading methods;" or (b) "the extent to which other Hampton clients used Wilson's methods;" (2) whether respondents had executed unauthorized trades; (3) whether the complaint was filed in a timely manner;14 and (4) the amount of damages.
Respondents' prehearing memorandum identified one issue arising out of the claims raised in the complaints - whether McGough authorized the transactions executed for his accounts. Respondents described several other issues related to their affirmative defenses, including whether McGough: (1) failed to file his claims within (a) the one-year limitations period contained in his customer agreement with Iowa Grain or (b) the Act's two-year limitations period; (2) waived any right to recover from Iowa Grain by executing a customer agreement that required him to hold Iowa Grain harmless from losses "allegedly caused by wrongdoing on the part of Complainants' introducing broker;"15 (3) ratified the transactions in his accounts by failing to make a timely objection; and (4) failed to mitigate damages.
Less than a month before the hearing, McGough filed an
amendment to his prehearing memorandum. The amendment described a new theory of
recovery based, in part, on a failure to disclose:
[A]t no time [were complainants] properly advised as to the hypothetical nature of Dr. Perry Wilson's trading activities and as such, relied upon the material representations that actual trades were being conducted by Dr. Perry Wilson and other clients of the Hampton Group . . . . Consequently, all of the trades that were predicated upon the purported actual trading of Dr. Perry Wilson were fraudulent in nature and misrepresented material facts.
McGough's amended prehearing memorandum also asserted that respondents' conduct violated NFA disclosure rules regarding hypothetical trading.
The ALJ conducted a hearing on May 4, 1998 in Los Angeles. Both complainants and respondents were represented by counsel. McGough testified on his own behalf and called respondent Bradford and Hampton Group owner Gary Kummer as witnesses. Bradford and Kummer also testified for respondents.
In opening argument, McGough's attorney reiterated that McGough relied on assurances that his account was being traded according to actual orders placed by Perry Wilson, and also argued that unauthorized trading took place when McGough left town. Tr. at 8-9. Respondents' attorney's opening statement countered that McGough "was well aware that there were two types of trading in the account. There was hypothetical trading and there was some real time." Tr. at 13. The attorney also characterized McGough's claim of unauthorized trading as an "egregious case of somebody simply making a misrepresentation to the court." Id.
McGough testified that before opening his Hampton Group accounts, he had maintained managed futures accounts for several months at three other firms. He had deposited $10,000 to margin trading in each of two accounts and $50,000 to margin trading in the third. He ceased trading two accounts after losing 25 percent of his equity; his first account, opened in 1994, remained open and inactive at the time of the hearing. Tr. at 19-22.
McGough claimed that at the time Busby solicited him to open his Hampton Group account, he advised the account executive that he wanted to trade conservatively in light of the losses he had already suffered trading futures through other firms. After depositing $50,000 into his nondiscretionary account, McGough placed one T-bond trade. No further trading took place until Bradford called in April. Tr. at 22-25.
According to McGough, "Jim called to say he had a client of the Hampton Group that was very successful in trading the S&P 500 contract and that his name was Dr. Wilson and . . . as I recall, that Wilson was doubling his money every six to eight months." Tr. at 32. McGough explained that Bradford "would say, for example, '[t]he doctor is taking a ten-contract position in the S&P, and we think your account should take, say, two,' or something less, anyway, because Dr. Wilson's account was substantially larger than mine." Tr. at 32. He testified that Bradford told him Wilson's account was "between a half and a million dollars." Tr. at 33.
McGough said that he relied on Bradford's oral representations as to how Wilson was trading when he approved individual trades for his account. He did not receive faxes for every day on which trading occurred--"sometimes [Bradford] would send the faxes, sometimes he wouldn't"--and those faxes he did receive "usually" arrived after the trading orders they described. Tr. at 41. He testified that after June 19, 1995 he only received a single fax. According to McGough, Bradford sent this final fax in early 1996, after both Iowa Grain accounts were closed. Id.
McGough testified (on redirect examination) that he believed the Wilson trades that Bradford discussed with him were real until shortly before the hearing when his attorneys suggested that they were hypothetical. Tr. at 135-36. He also insisted that he would not have traded based on Wilson's strategy had he known that any of the trading was hypothetical. Tr. at 39; see also Tr. at 27 ("hypothetical was never mentioned in my dealings with the Hampton Group").
McGough did acknowledge that respondents had not
solicited him to open his second Iowa Grain account. He explained that by
[T]he first account was doing reasonably well. It had a liquidation value of about $94,000. And I decided I would open a second account for $100,000.
Tr. at. 37.
During cross-examination, respondents' counsel asked McGough why he failed to ask about differences between the trades executed for his account and the trades described in the Wilson's faxes.16 McGough replied that "[i]t never dawned on [him]," because "[he] trusted Jim." Tr. at 84. Counsel also questioned McGough about the April 27 fax's reference to "paper trading." When asked how he interpreted this reference, McGough noted that there was a reference to "real time," in the same sentence and explained that he believed the sentence meant that Wilson "did it in real time from October the 25th, 94 to the end of 94, and he made 18,605." Tr. at 88.17
In response to questions about information disclosed in the account statements he had received, McGough testified that he had trouble reading the statements. He expressed surprise upon being shown an account statement indicating that he had suffered a $42,000 loss in a three-day period. Tr. at 115.
While McGough was being cross-examined, respondents' attorney attempted to ask him about a document purporting to summarize the results of trades executed in an account that respondent Wilson traded through the Hampton Group. The ALJ instructed the attorney to call Bradford to the stand to authenticate the document prior to using its contents to cross-examine McGough. Bradford testified that the summary reflected actual trading results for Wilson's personal account. Under questioning by the ALJ, however, Bradford acknowledged that Wilson controlled the trading in several Hampton Group customer accounts. Because the document at issue did not reflect the results of trades executed for these accounts, the ALJ refused to either allow the summary into evidence or permit counsel to use it as a basis for cross-examining McGough. Tr. at 96-99.
When McGough began to testify about his unauthorized trading allegations, the ALJ intervened, sua sponte, and dismissed the claim. The ALJ explained that his ruling would expedite matters by limiting testimony and evidence to that bearing on fraudulent inducement. Tr. at 45-46.18 In light of his earlier ruling, the ALJ later prevented respondents' counsel from questioning McGough about unauthorized trading allegations, saying "I threw out the unauthorized trading. I don't know why you're dwelling on this." Tr. at 129. The ALJ did permit respondents to introduce phone records obtained from a telephone company that included a printout of all calls to and from the Hampton Group's 800 number during the relevant period.19
During his testimony, Bradford acknowledged mentioning the success of Wilson's trading system to McGough. Bradford indicated that Wilson had maintained an actual trading account with the Hampton Group since 1992. He testified that he learned of Wilson's trading success from Jack Keesey, Wilson's broker at the Hampton Group. Bradford claimed that he had never spoken to Wilson at the time he solicited McGough to trade based on Wilson's system, but emphasized that he did not intend to misrepresent anything. He said that in recommending Wilson's trading system to McGough, "[he] did not verify his paper trading, [he] looked to his real account." Tr. at 162. He explained that he "was truly enthused by how well this guy was trading, and . . . wanted Joe [McGough] to have a part of that." Tr. at 147.
Bradford acknowledged that some of the trades described in the faxes that he provided to McGough may have been hypothetical.20 He was also aware of his obligation to provide disclosure about track records of trading success affected by hypothetical trades. Tr. at 155-56. He claimed that the reference to "paper trading" in the April 27, 1995 fax made it "obvious" that some of Wilson's trades were hypothetical. Tr. at 151.21 Moreover, he claimed that each of the faxes that he sent to McGough included language disclosing the risk of relying on track records affected by hypothetical trades. Tr. at 157-58.22
Contrary to McGough's testimony, Bradford testified
that McGough's trades generally included larger positions than those Wilson
established in his personal account:
[McGough's] account size was much greater than [Wilson's]. You know, the doctor may have had several accounts that [in the aggregate] represented quite a bit of money, but the actual Perry Wilson account was not of the size of Joe McGough's, so of course, when we would do a recommendation . . . if the doctor was doing one, we would do five. If he was doing two, we would do ten, whatever the case may have been.
Id. at 200. Bradford also specifically denied that he had ever used the terms "million dollars" or "half-million dollars" in talking to McGough about Wilson's trading. Id. at 214-15.
The Hampton Group's owner, Garry Kummer, appeared as a witness for both complainants and respondents. Kummer acknowledged that the Hampton Group's relationship with Wilson was not limited to the typical customer-IB relationship, but insisted that the Hampton Group had never employed Wilson.23 He explained that he had initially agreed to sponsor Wilson for registration even though Wilson intended to work from his home in Canada.
Kummer said that he later withdrew his sponsorship before Wilson's registration became final because he did not want to undertake the supervisory responsibility that such a relationship would entail. Tr. at 175-82.
Kummer acknowledged that after Wilson became registered as a CTA, he agreed to steer his clients to Jack Keesey so that their FCM accounts would be opened through the Hampton Group. Kummer also indicated that he was aware that fliers promoting Wilson's services indicated that he was "associated with the Hampton Group." Kummer agreed that at least one of the fliers had been sent from the Hampton Group's offices despite his claim that he never authorized Hampton Group personnel to disseminate them.
The Parties' Posthearing Submissions
The parties filed posthearing briefs and proposed findings of fact and conclusions of law. Complainants' submissions included arguments that (1) Bradford fraudulently induced McGough to trade by misrepresenting that Wilson's hypothetical trading system achieved actual results that were highly profitable, and (2) respondents failed to provide the written disclosure about the risks of hypothetical trading required by Commission and NFA rules. Complainants also argued that the ALJ should award damages based on the unauthorized trading claim that he had dismissed at the hearing.
Respondents Bradford and the Hampton Group filed a joint post-hearing brief. They reiterated their claim that the complaints were untimely. They also insisted that McGough's utter lack of credibility undermined all his claims. They emphasized documents indicating there had been a substantial number of telephone calls between McGough and respondents during the time McGough said no calls occurred. They also challenged McGough's claims that he did not understand either his account statements or the meaning of the April 27 fax's reference to "paper trading."
Respondents argued that even if the record established liability, McGough had failed to show that any of the alleged wrongdoing was the proximate cause of the losses in the second account. In this regard, they emphasized McGough's own testimony admitting that he opened the second account on his own initiative and at a time when he was aware that the equity in his first account was $6,000 less than the amount he had deposited.
Iowa Grain's brief argued that even if the ALJ found that the Hampton Group was liable for complainants' damages, there was no basis for holding it jointly and severally liable. It argued that liability could not be imposed under the Commission-mandated guarantee agreement because there were procedural and substantive errors in the rulemaking establishing the agreement. In addition, Iowa Grain emphasized that complainants had executed account agreements that waived both their right to rely on the Act's two-year statute of limitations and their right to impose liability on Iowa Grain for the acts of either its introducing brokers or their employees.
The ALJ issued his Initial Decision awarding complainants their full out-of-pocket losses in September 1998. McGough v. Bradford, [1998-1999 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,420 (Sept. 11, 1998) ("I.D."). The ALJ held that the only issues remaining for decision were whether McGough was fraudulently induced to open and/or trade the accounts and whether respondents fraudulently led McGough to believe that certain hypothetical trades were in fact actual trades.
The ALJ did not make general credibility assessments of
the three witnesses at the hearing. He did specifically find that portions of
Bradford's testimony were not credible, and apparently credited at least portions
of Kummer's testimony. I.D. at 46,993-94. The ALJ credited most elements of
McGough's testimony. See, e.g., I.D. at 46,992, 94. As for McGough's
sworn statement claiming that complainants did not have telephone contact with
respondents for two weeks in July 1995, the ALJ explained that:
I do not believe that McGough made these allegations in bad faith. He truly believed he had had no telephone conversations during that period of time. This flaw in his testimony does not make him an unbelievable witness.
I. D. at 46,995.
The ALJ found that the faxes Bradford provided to McGough were deliberately misleading:
The facsimiles are laced with misinformation, and designed to mislead the gullible and unsophisticated. McGough was led to believe that Wilson had a trading system that was producing huge profits.
I.D. at 46,993. The ALJ found that Bradford "deliberately" caused McGough to believe that Wilson was making huge profits on futures transactions that were actually executed, id., and that McGough's consent to trades entered after April 17, 1995, was predicated on "false information he received from Bradford." I.D. at 46,994.
Based largely on the absence of evidence to the contrary,
the ALJ inferred that Bradford's deception was only one element in an elaborate
scheme to defraud complainants. In this regard, he suggested that none of the trades
described in the faxes were actual trades:
[T]here is not a scintilla of probative evidence in the record to show that Wilson ever traded a single S&P contract. Nevertheless, Wilson's facsimiles were sent to McGough, and McGough relied on those facsimiles to trade his account. McGough, of course, believed that Wilson was actually entering trades. The testimony of Bradford and Kummer make it abundantly clear that the Wilson facsimiles were not instructions to place futures positions in Wilson's account, but instead a concocted hypothetical trading scheme designed to delude the gullible into believing the instructions were for actual trades."
I.D. at 46,995. The judge also emphasized that:
The overwhelming weight of the evidence establishes that Wilson was neither a wealthy medical doctor nor a genius S&P trader. Rather, he was part and parcel of the scheme designed to separate McGough from his money.
In light of these findings, the ALJ concluded that Bradford, Wilson and the Hampton Group had violated Section 4b(a) of the Act and proximately caused McGough's losses. He concluded that Iowa Grain was jointly and severally liable for the payment of these damages under its guarantee agreement with the Hampton Group. Id. The judge did not address any of respondents' arguments relating to affirmative defenses.
Submissions on Appeal
All respondents, including Wilson, filed timely notices of appeal. Iowa Grain, the Hampton Group and Bradford filed a joint appeal brief raising four issues. First, they argued that the ALJ erred in refusing to allow Wilson's trading records into evidence. Second, they challenged his credibility findings in McGough's favor. Third, they contended that the ALJ erred by acting as an advocate for complainants. Fourth, they contended that the ALJ erred by failing to consider their affirmative defenses.24
Perry Wilson joined the other respondents' appeal arguments, and also filed a separate brief arguing that the Commission lacked jurisdiction over him in its reparations forum because he was not a registrant during the period McGough's account was traded.
Complainants filed an answering brief that urged the
Commission to strike several of respondents' submissions on appeal and affirm the
ALJ's Initial Decision.
Before turning to the substantive points that the parties
have raised, we review several preliminary matters that affect the contours of the
issues material to the outcome of this proceeding.
Complainants' Motion to Strike
Complainants urge us to strike documents that respondents submitted in the appendix to their appeal brief. In effect, they argue that respondents are seeking to evade the requirements that Commission Rule 12.405 imposes on parties who seek to reopen the evidentiary record on appeal.
The Commission's reparation rules do not contemplate
the filing of an appendix with appeal briefs. Compare Commission Rule 12.401
with Commission Rule 10.102. Moreover, with the exception of their two posthearing
briefs, all the documents included in respondents' appendix are evidentiary in
nature.25 One of the documents is an
exhibit complainants introduced at the hearing.26 Another document - the summary of the trading results in the P.G.
Wilson, Prof. Corp. account -- is an exhibit that the ALJ refused to admit at the
hearing.27 As to the new evidentiary
submissions - the affidavit prepared by respondent Wilson and the Iowa Grain account
statements for the P.G. Wilson, Prof. Corp. account -- respondents must justify
reopening the evidentiary record to receive these documents. In order to do so,
respondents must show that (1) the evidence is material, and (2) there were reasonable
grounds for failing to adduce the evidence before the ALJ. Because respondents have
failed to make any showing on the second factor, there is no basis for reopening the
On these bases, with the exception of the exhibit rejected by the ALJ, we strike the appendix to respondents' appeal brief.
Respondents' Challenge to the ALJ's Evidentiary Ruling
As noted above, at the hearing the ALJ denied respondents' request to introduce a summary of one of the accounts that respondent Wilson traded through the Hampton Group. In essence, the ALJ ruled that these records were not reliable evidence of the performance of the trading system described in the faxes that Bradford provided to McGough. On appeal, respondents emphasize that this document as well as the account statements that they submitted on appeal are clearly relevant to a showing that (1) Wilson actually executed trades in the S&P futures contract during the period McGough maintained his Iowa Grain accounts, and (2) the results of the trades that Wilson actually executed are consistent with the performance record described in the faxes that Bradford provided to McGough.
In making this argument, respondents emphasize language in the Initial Decision reflecting the ALJ's suspicion that none of the trades described in the faxes that Bradford provided to McGough were actually executed. Such suspicions, however, are not an appropriate basis for imposing liability under the Act. Similarly, evidence cannot be deemed relevant simply because it might disprove suspicions that are immaterial to assessing liability in the circumstances of this case.
In any case, there is no basis for inferring that the performance summary of the trading in the P.G. Wilson, Prof. Corp. account reflects the track record of the trading system addressed in the faxes that Bradford provided to McGough.29 Respondents admit that the trading system addressed in the faxes is used for both actual and hypothetical trading. In these circumstances, an accurate description of the trading system's track record must reflect the results of both the actual and hypothetical trading results. Consequently any reference to the track record of the trading system is misleading if it does not (1) note the hypothetical trading, and (2) disclose the risks of relying on a track record affected by hypothetical trading. The underlying deception is not dispelled by proof that some trades selected by the trading system not only were actually executed but also resulted in a substantial profit. Put simply, in the circumstances of this case, evidence regarding the results of the actual trading in Wilson's account is irrelevant to respondents' liability.
Respondents' Statute of Limitations Defenses
Respondents argue that McGough's complaints should be dismissed as untimely. They contend that the record shows that McGough's claim based on deception accrued in either April or May 1995. Consequently, they argue that the one-year limitations period imposed in Iowa Grain's customer agreement with McGough lapsed in April or May 1996, and that the Act's two-year limitations period lapsed in April or May 1997. They contend that complainants' August 1997 filing with the Commission was too late under either standard. Complainants insist that McGough's claim based on deception did not accrue until he closed the accounts in August 1995 and that his August 1997 filing is timely under the Act's two-year limitations period.
Our precedent recognizes that a cause of action accrues and the two-year limitations period begins to run when complainant discovers the wrongful activity underlying his claim, or, in the exercise of reasonable diligence, should have discovered the wrongful activity. Edwards v. Balfour Maclaine Futures, Inc., [1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,108 at 41,665 (CFTC June 16, 1994). In determining when wrongful activity should have been discovered, we look to the particular facts and circumstances of each case, including (1) the relationship of the parties; (2) the nature of the wrongful activity; (3) complainant's opportunity to discover the wrongful activity; and (4) the actions taken by the parties subsequent to the wrongful activity. Id.
In analyzing McGough's claim based on deception, we look to when complainant should have known that respondents had deceived him about the nature of Wilson's trading system's track record. We find little or no persuasive evidence that the April or May dates advocated by respondents are appropriate.30 Trading in McGough's accounts ceased on August 18, 1995 and the accounts were closed formally in October 1995. We find that by the earlier date, McGough was on notice of sufficient circumstances that he should have known at least the general outline of the significant elements of respondents' deceptive conduct.
Under the reparations rules, mailing constitutes filing. See Commission Rules 12.13(c); 12.10(a)(2). McGough executed his notarized complaints on August 5, 1997 and the complaints were received in the Office of Proceedings on August 8, 1997. Consequently, his complaints were filed within the Act's two-year limitations period but outside the one-year period established in Iowa Grain's customer agreement.
In effect, Iowa Grain's customer agreement compels its customers to waive the Act's two-year limitations period and substitute a one-year period. In order to enforce such a waiver, we must determine that it comports with Congress' intent in establishing the reparations process.
Respondents emphasize that the Supreme Court has recognized that parties to a contract may agree to limit the time for bringing an action on such contract to a period less than that prescribed in the general statute of limitations as long as (1) the shorter period is reasonable, and (2) there is no controlling statute to the contrary. See Order of United Commercial Travelers of America v. Wolfe, 331 U.S. 586, 608 (1947). Respondents argue that Section 14 of the Act is not such a controlling statute because it does not expressly prohibit the waiver of the two-year period.31
The specific holding in Wolfe is largely inapposite to the circumstances of this case. Complainants are seeking to enforce their rights under the Act rather their rights under their agreement with Iowa Grain. Also, there is no general statute of limitations at issue in this case. The limitations period applicable here was expressly created by Congress to govern claims involving violations of the Act and Commission regulations raised in the Commission's reparations forum.
Respondents do not cite the holding of any court to support their contention that Congress may only indicate its intent to forbid contractual waivers expressly.32 Indeed the recent opinion of the United States Court of Appeals for the District of Columbia Circuit in First American Discount Corp. v. CFTC, No. 99-1098 (August 18, 2000) ("FADC") stands in sharp contrast to respondents' insistence that form must take precedence over substance in analyzing the enforceability of contract provisions waiving statutory rights.
In FADC, petitioner challenged the
Commission's conclusion that a contractual provision waiving an FCM's
liability for the conduct of its guaranteed IBs was unenforceable because it was
incompatible with Commission Rule 1.10(j). Under respondents' theory of
interpretation, the court in FADC should have limited its inquiry to whether
the Commission regulation at issue expressly stated that waiver was not permissible.
Because Commission Rule 1.10(j) does not address the question of waiver, the
appropriate inquiry under respondents' theory would have led the court to apply
the contract provision at issue. The court in FADC, however, concluded that the
contract provision was not enforceable because it was contrary to the intent
underlying Commission Rule 1.10(j). FADC, slip op. at 14. In determining
intent, the court looked to both the language of the rule and its regulatory purpose
and emphasized that:
[J]ust as we must defer to the agency's reasonable interpretation of the statutory scheme it was entrusted to administer, so too must we give its interpretation of its own regulations "controlling weight unless it is plainly erroneous or inconsistent with the regulation."
FADC, slip op. at 14. This approach to determining whether a regulatory provision is subject to waiver is clearly incompatible with the approach focused on express intent that respondents urge us to apply in this case.
The two-year limitations period established in Section 14(a)(1) of the Act is also reflected in Commission Rule 12.13(a). If the provision in Iowa Grain's contract waiving the two-year limitations is incompatible with the intent underlying either of these provisions, it is unenforceable in the reparations forum. We conclude that Iowa Grain's contract provision is incompatible with both Congress' intent in enacting Section 14(a)(1) and the Commission's intent in enacting Rule 12.13(a).
When the Commission first adopted its reparations rules,
language relating to the applicable limitations period was included in Rule 12.21.
Former Rule 12.21 provided that a person complaining of a violation of the Act or
Commission regulations could apply to the Commission for a reparations award "at
any time within two years after the cause of action accrues." At the same time,
the Commission adopted former Rule 12.1, which stated that:
The rules in this part shall be construed liberally so as to secure the just, speedy and inexpensive determination of the issues presented with full protection for the rights of all parties to the proceeding envisioned by the [Act].
In the preamble to the adoption of the original
reparations rules, the Commission noted that:
These reparation rules provide the procedures by which a claimant may pursue one of the remedies the law will permit for the recovery of claims. The other available remedies are arbitration and the filing of a lawsuit in an appropriate state or federal court.
Rules Relating to Reparation Proceedings, 41 Fed. Reg.
3994 (Jan. 27, 1976.)
Nine months later, the Commission adopted rules addressing the use of pre-dispute arbitration agreements to waive a customer's statutory right to file a reparations claim. Rule 180.3 not only prohibited any agreement that required a customer to waive the right to seek a reparations award under Section 14, but specifically required that any demand for arbitration include a written notice that the affected customer could elect to seek a reparations award within 45 days. In the preamble to the adoption of this rule, the Commission noted that:
The legislative history of the Act indicates that Congress "expected the Commission to publish regulations" "to implement and coordinate" reparations and other dispute settlement procedures "and their utilization and availability for resolution of disputes." . . . Since pre-dispute arbitration agreements are used by the entire industry, such agreements would effectively preclude a customer from seeking reparations as provided in Section 14 . . . thus depriving customers of the remedial effects of the 1974 amendments to the Act.
Voluntary Procedure and Compulsory Payments, 41 Fed. Reg. 42942, 42,944-45 (Sept. 29, 1976) (footnote omitted). The Commission also noted and rejected a commentator's claim that the Commission could not invalidate pre-dispute arbitration agreements that waived a customer's right to reparations because the Act lacked an express statutory provision barring the waiver of statutory rights. 41 Fed. Reg. at 42,944.33
These statements make it clear that the Commission has always viewed the reparations forum as an important supplement to the alternative forums offered by courts and arbitration and believed that contractual agreements waiving a customer's right to submit claims to the reparations forums were void. These views are the key to the analysis in this case because enforcement of contractual provisions waiving Rule 12.13(a)'s two-year limitations period is likely to have the very result that Rule 180.3 was intended to preclude.
The Commission's experience with reparations cases shows that many futures customers are both comparably unsophisticated about the market and generally inexperienced with legal proceedings. Obtaining competent counsel with expertise in the complexities of both the futures market and the applicable legal standards often involves a significant commitment of time and money. Customers traumatized by the rapid loss of substantial sums are understandably reluctant to commit the necessary resources. In consequence, they often find it difficult either to recognize misconduct under the CEA or to take effective steps to protect their interests.
Even after two years, many customers have at best a rudimentary understanding of the complex facts and circumstances that may affect their claims. If these customers were required to initiate a reparations complaint within one year of the wrongdoing, it is likely that many would, as a practical matter, be denied a reasonable opportunity to present their claims.34
When the issue is viewed from this perspective, the fact that Illinois law (by which Iowa Grain's contract purports to be governed) recognizes a one-year limitations period as reasonable for contract actions is neither controlling nor persuasive. The issue for the Commission is whether registrants should be free to rewrite a basic statutory element of the Commission's reparations program through contracts with individual customers. While permitting such a waiver by sophisticated customers in a position to bargain with their FCM might be appropriate when there are appropriate safeguards,35 the customers most likely to seek relief in a reparations proceeding do not fall within this class.
Accordingly, we conclude that the contractual waiver accomplished by the limitations provision in Iowa Grain's customer agreement is contrary to Commission Rule 12.13(a).36 On this basis, we decline to enforce it.
The ALJ's Credibility Assessment
Respondents challenge the ALJ's general crediting of McGough's testimony. They emphasize the ALJ's indifference to substantial evidence indicating that McGough's sworn statement claiming that complainants were not in telephone contact with respondents between July 6 and July 22, 1995 was false. In addition, they contend that the ALJ's explanation for McGough's deception - that McGough "truly believed he had had no telephone conversations during that period of time" - is unsupported by the record. Finally, respondents note that at the hearing the ALJ prevented counsel from questioning McGough about his statement denying contact with respondents during the period that he was on vacation. Complainants urge us to defer to the ALJ's credibility assessment under the principles set forth in Secrest v. Madda Trading Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,627 (CFTC Sept. 14, 1989).
As noted in Secrest, the Commission defers to a presiding officer's credibility assessment in the absence of clear error. In this case, the ALJ committed two errors that undermine our confidence in the reliability of his credibility assessment. First, he abused his discretion by limiting counsel's questioning of McGough at the hearing about his sworn statement claiming that complainants were not in telephone contact with respondents between July 6 and July 22, 1995. The judge's goal of expediting the hearing in this matter cannot justify either the arbitrary dismissal of complainants' unauthorized trading claim or the limitations imposed on respondents' counsel's cross-examination of McGough. Without regard to its underlying subject, complainant's sworn statement was relevant to an assessment of McGough's credibility.
In addressing the contradiction between the telephone records submitted by respondents37 and McGough's sworn statement, the judge essentially found that McGough had forgotten about the calls reflected on the telephone records. Respondents correctly note that McGough never testified that he forgot about the calls. Nor can reasonable inference be drawn from other reliable evidence to support this finding. Moreover, McGough's assertion that after he returned home he called the Hampton Group for the limited purposes of demanding why trading had occurred in his absence and calling a halt to trading until further notice is flatly contradicted by the telephone records. The level of contact shown by these records cannot be squared with a finding that McGough forgot his contacts with respondents.
Given these defects in the ALJ's credibility assessment, we have undertaken a de novo assessment of witness credibility. Overall, we find substantial reasons to question the credibility of all the witnesses. The flaws in McGough's sworn statement in support of his unauthorized trading claim suggests that he was prepared, at best, to bend the truth if such a deception was necessary to recover his lost funds. Bradford's testimony about the hypothetical trading disclosure he allegedly made on all of the faxes sent to McGough is equally fantastic.38 Finally, Kummer's admission that he signed an important regulatory document undertaking supervisory responsibilities over Wilson without either seriously considering how he could fulfill the responsibilities or carefully reviewing the information reflected in the document raises a substantial question about his credibility.
Given these patent defects in the credibility of all of the witnesses, we have carefully reviewed the record with an eye toward the documentary evidence material to McGough's claim based on deception. Our findings, which are noted below, are based on areas of general agreement between the parties and inferences drawn from documentary evidence such as the faxes that Bradford sent to McGough and the account statements that Iowa Grain provided to McGough.
Respondents' Deceptive Conduct
Stripped to its essentials, this case turns on whether respondents' allegedly deceptive conduct led McGough to maintain and increase his investment in the first account and to establish and fund his second account. The parties agree that Bradford called McGough and urged him to follow Wilson's successful trading system. They also agree that Bradford sent faxes to McGough with information about the trades generated by the system and the system's track record. Finally, the parties agree that some of the trades discussed in the faxes were hypothetical.
Bradford himself acknowledged that he never told McGough that the successful track record for Wilson's system was partially based on hypothetical trading. Without this information, McGough was not in a position to assess the reliability of the track record underlying Bradford's references to Wilson's successful trading system. Consequently, Bradford's solicitation was deceptive. We infer that, at best, Bradford's deception was in reckless disregard of his duty to disclose material facts accurately.39
Respondents' claim that the April 27 fax's reference to "paper trading" cured the initial deception by disclosing that some of Wilson's trades were hypothetical is not persuasive. The pertinent language of that fax -- " since I began paper trading this system in real time" - is, at best, ambiguous. Respondents' argument ignores relevant circumstances indicating that a reasonable customer would have little incentive to pay strict attention to isolated statements in one fax. Moreover, given respondents' inability to agree on precisely which of Wilson's trades were hypothetical and which were not, it is difficult to see how the vague language in the April 27 fax can be viewed as meaningful disclosure of this "fact." 40
In any case, disclosure that some of the trades were hypothetical would only be the first step in curing the deceptive element of Bradford's solicitation. Respondents were also obliged to disclose the risks of relying on any record of "success" based on hypothetical trades. The Commission's rules mandate that specific language of disclosure must be used; anything falling short of that is an actionable violation. See Commission Rule 4.41(b).41
When respondents' deceptive conduct involves a
failure to disclose, there is a rebuttable presumption that complainant relied on the
undisclosed information.42 The issue
then is whether the record shows that McGough would have been indifferent had Bradford
disclosed that (1) the track record for Wilson's trading system was affected by
hypothetical trades and (2) track records affected by hypothetical trades involve
risks relating to reliability.
We conclude that the record is insufficient to rebut the presumption of reliance. As noted above, the April 27, 1995 fax's reference to "paper trading" was too ambiguous to provide notice that hypothetical trading was taking place. Aside from Bradford's incredible testimony about the disclosure he supposedly included in the faxes he sent to McGough, there is no evidence tending to show that McGough became aware of the risks of relying on track records affected by hypothetical trading while his Iowa Grain accounts were open.
The record clearly shows that respondents' deceptive conduct played a substantial role in McGough's maintenance of and increased investment in his initial account.43 McGough had ceased trading in the initial account when Bradford informed him about the successful track record of Wilson's trading system. In essence, he and Bradford agreed to test the system to see whether it could generate profits. Initial trading success was followed by McGough's addition of $50,000 to the account on May 1, 1995. We infer that McGough submitted these funds and continued to trade the account because he believed he would earn significant profits by following a trading system with a successful track record.
Nevertheless, the record compels a different conclusion as to the losses that McGough suffered in his second account. The parties agree that McGough opened the account on June 15, 1995 on his own initiative, without any consultation with or prompting by Bradford. McGough acted in a similar independent manner when he established his first Iowa Grain account and made his initial deposit of $50,000. McGough was clearly capable of committing significant resources to futures trading in the absence of material deception.
At the time McGough opened the second account, the value of the first account had risen to $94,000 from a marked-to-market value of $81,000 at the end of May. Even so, this was $6000 less than the $100,000 he had deposited. Such a mixed record provides, at best, a questionable basis for risking an additional $100,000 in the futures market. Accordingly, we dismiss the complaint in Docket No. 97-R117 for a failure to prove any damages.
Mitigation of Damages
Respondents argue that the record shows that complainants
failed to mitigate their damages. In this regard, they emphasize that the April 27 fax
gave McGough notice of some aspects of Bradford's alleged deception. They also
focus on McGough's testimony about limiting his losses to 25% of his investment
and note that complainants were on notice that this loss limit had been breached as
early as May 23, 1997.
Commission precedent recognizes that a duty to mitigate damages may arise in some circumstances. Sansom Refining Co. v. Drexel Burnham Lambert, Inc., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,596 (CFTC Feb. 16, 1990). In the context of deception, however, the duty to mitigate damages does not arise "unless the record establishes that the defrauded individual has become aware of the material facts about which he was initially misled." Levine v. Refco, Inc. [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,488 at 36,116 (CFTC July 11, 1989). Because respondents failed to show that while his accounts were open McGough ever learned that the successful track record that Bradford touted was partially based on hypothetical trades, they cannot establish the necessary predicate for their mitigation defense.
Wilson's Role in Respondents' Deceptive Conduct
Despite Wilson's failure to participate in the proceeding, the ALJ made findings of fact about his role in Bradford's deception of McGough. In light of these findings, the ALJ held that Wilson was jointly and severally liable for the damages awarded to complainants.44 As indicated above, Wilson's appeal brief separately argued that: (1) the Office of Proceedings erred in forwarding the complaint to him, and (2) the ALJ erred by exercising jurisdiction over him. These arguments focus on the undisputed fact that Wilson was not registered at the time of the wrongdoing at issue in the complaints.45
Wilson essentially claims that his unregistered status at the time of the wrongdoing placed him outside the jurisdiction that Congress granted the Commission in Section 14(a) of the CEA. That provision does limit the Commission's jurisdiction to actions against "any person who is registered under this Act . . . ." It does not, however, specify the "time frame" during which a respondent's registration status is determined. Nevertheless, Commission precedent makes it clear that the time of the alleged violation is not the only appropriate time frame for evaluating a respondent's registration status.
Rule 12.2, as relevant here, defines
"registrant" for purposes of reparations actions as "any person who was
registered under the Act at the time of the alleged violation" or who "is
otherwise subject to reparation proceedings under the Act . . . ." While
Wilson was not registered either at the time of the wrongdoing or at the time the
complaint was filed, he was registered for a period of several months between those
two events.46 The Commission has
held that "its [reparations] jurisdiction . . . extend[s] to persons who, while
not registered at the time the violation occurred, later become registered . . .
." Nelson Inc. Retirement Trust v. Diversified Investment Group, Inc.,
[1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,627 at 30,679 (CFTC June 5,
1985). The Commission explained that:
[t]he exercise of our reparations jurisdiction over both those who are registered at the time of the violation and those who become registered thereafter fully effectuates Congressional intent in amending Section 14(a) in 1982. Thus, we will normally exercise our jurisdiction and adjudicate claims against individuals who were registered at the time of the violation as well as those who become registered during the two-year limitations period.
The reasoning in Nelson disposes of Wilson's jurisdictional challenge. To affirm the ALJ's award of damages, however, the Commission must satisfy itself that the complaints stated a cognizable claim against Wilson, and that nothing in the record fatally undermines the substance of that claim.
McGough's complaints alleged that "Bradford and the Hampton Group misrepresented the accuracy and profitability of the trading system being touted by Dr. Perry G. Wilson . . . ." Id. at ¶ 18. McGough never met or talked to Wilson, and in the course of this proceeding never asserted that Wilson acted with specific fraudulent intent toward him. McGough argued in his prehearing memorandum that Bradford and the Hampton Group misrepresented "the nature and success of Wilson's trading methods" and the extent to which other Hampton Group clients used and relied on Wilson's system.
In these circumstances, Wilson is liable, if at all, as an aider and abettor under the Act. Such liability requires proof that (1) the Act was violated, (2) the named respondent [in this case, Wilson] had knowledge of the wrongdoing underlying the violation, and (3) the named respondent intentionally assisted the primary wrongdoer. See In re Nikkhah, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 28,129 at 49,888 n.28 (CFTC May 12, 2000). In appropriate circumstances, passive conduct may amount to intentional assistance. See In re Western Financial Management, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,814 at 31,401 (Nov. 14, 1985).
To conclude that the record supports the findings necessary to support an aiding and abetting claim against Wilson, we would have to draw negative inferences from Wilson's refusal to participate in this proceeding. Cf. In re Citadel Trading Co., [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,082 at 32,189 (CFTC May 12, 1986). Bradford testified that Wilson was acting directly as a trader for certain customers of the Hampton Group. Also, Bradford's and Kummer's testimony, as well as the text of some of the faxes in the record, indicates that Wilson was aware that Bradford was using trades generated by Wilson's trading system to recommend trades to Bradford's customers.47
This evidence, considered in the context of the negative inference arising from Wilson's failure to participate, arguably is a sufficient basis to conclude that Wilson knew that Bradford was using his strategy without providing proper disclosure to the customers relying on it. Wilson's interest in obtaining Kummer's sponsorship for his registration gave Wilson an incentive to ignore his knowledge respondents were using his trading system without making appropriate disclosure. The absence of evidence that Wilson was receiving direct compensation for the Hampton Group's use of his trading strategy is simply not dispositive. This type of indirect benefit provides an arguable basis to infer that Wilson's silence amounted to intentional assistance of respondents' unlawful venture.
The foregoing reasoning colorably supports an award of damages against Wilson.
Nevertheless, due to McGough's pro se status at the time he prepared the complaints, Wilson was not given fair notice that his liability as an aider and abettor was at issue. Neither the prehearing memoranda nor even counsels' presentations at the hearing cured this defect. Indeed, the ALJ's minimal analysis of Wilson's role in the Initial Decision is at least partly a product of complainants' failure to articulate a theory of liability applicable to Wilson.
Wilson's failure to appear and participate in this proceeding, however, cannot be condoned. It effectively denied McGough a fair opportunity to use the discovery and hearing process to develop the record about Wilson's relationship with respondents and knowledge of respondents' deceptive conduct. We will not reward Wilson for his disregard of this forum by dismissing the claims against him.
In view of our dismissal of Docket No. 97-R117, we resolve this dilemma by vacating the liability findings and damage award against Wilson and remanding Docket No. 97-R116 to the ALJ. The remand shall apply only to respondent Wilson. On remand, complainants should be given an opportunity to seek discovery from Wilson and compel his attendance at a hearing for purposes of cross-examination. If Wilson fails to cooperate with the discovery process or to appear and testify at the scheduled hearing, the ALJ shall draw appropriate adverse inferences in determining whether Wilson aided and abetted respondents' deceptive conduct in Docket No. 97-R116.
Respondents' Affirmative Defenses
We have reviewed the arguments respondents raised in
their appeal brief regarding their affirmative defenses and find them all
unpersuasive. Their challenge to the enforceability of Iowa Grain's guarantee
agreement with the Hampton Group and arguments for enforcing the exculpatory clause in
Iowa Grain's customer agreement with complainants are unavailing. FADC, slip
op. at 7-14, 14-17. See also Violette v. First American Discount Corp.,
[1998-1999 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,563 (CFTC Feb. 24, 1999)
(rejecting the same affirmative defenses asserted by Iowa Grain in this
Based on the foregoing, we conclude that Bradford and the Hampton Group violated Section 4b(a) Act and Commission Rule 4.41(b) by failing to make appropriate disclosure about the hypothetical trades that affected the successful track record that Bradford used to promote Wilson's trading system to McGough. We conclude that Bradford, the Hampton Group, and Iowa Grain are responsible for the $94,298.24 in damages proximately caused by these violations in Docket No. 97-R116. We conclude that these violations were not the proximate cause of the damages at issue in Docket No. 97-R117. Consequently we dismiss the complaint in Docket No. 97-R117.
We vacate the ALJ's liability findings and damage award against Wilson and remand Docket No. 97-R116 to the ALJ as to Wilson only for additional proceedings consistent with this decision. Our remand of claims against Wilson shall not affect our resolution of complainants' claims against Bradford, the Hampton Group, and Iowa Grain. That resolution shall be final on the date this decision is served. Cf. Commission Rule 2.402(b).
IT IS SO ORDERED.48
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 28, 2000
1 James and Virginia McGough were the joint owners of the account at issue in CFTC Docket No. 97-R116. James and Rose Marie McGough were the joint owners of the account at issue in CFTC Docket No. 97-R117. Because James McGough ("McGough") was the only complainant actively involved in the opening or trading of either account, we refer to him as if he were the sole complainant.
2 The Commission's Office of Proceedings received McGough's complaints on August 11, 1997 and forwarded them to respondents in September 1997.
3 None of McGough's allegations of wrongdoing involve Busby.
4 The parties agree that McGough never had any direct contact with Wilson.
5 Account statements submitted with the complaints showed that the account had a cash balance of $49,761 on April 18. McGough executed several day and overnight trades in S&P 500 futures and options by the end of the month. McGough's monthly statement indicated that the market value of his account stood at $58,768.
6 Account statements showed that McGough realized a $5,995 profit on an S&P 500 options trade completed on May 1.
7 Account statements showed that McGough traded on 11 days during May. By the end of the month, McGough's account had no open positions and a cash balance of $81,313.
8 Account statements showed that McGough traded his initial account actively and unsuccessfully throughout June. By the end of the month, its market value had declined to $52,070. Account statements for the second account showed a similar result for June. That account lost one-third of its capital in two weeks of trading and closed the month with a market value of $63,933.
9 Account statements showed that McGough's initial account was traded actively throughout July. By the end of the month, the account's marked-to-market value had decreased to $38,917. Account statements showed that the second account was lightly traded during July. By the end of the month, the account's marked-to-market value had decreased to approximately $ 53,000.
10 Account statements showed that trading in the initial account continued through the first half of August. Only one transaction took place after August 18, the sale of the last open option position for $30. By the end of the month, the account's cash balance had fallen to $6,015. Account statements showed that trading in the second account continued until August 18, 1995. By the end of the month, the account's cash balance had fallen to $11,343. Iowa Grain returned both cash balances to McGough on September 29, 1995.
11 Respondents elected to pay the filing fee necessary to convert this matter from the voluntary proceeding that McGough had selected to a formal decisional proceeding.
12 Counsel retained by McGough during the discovery period prepared these requests.
13 Consistent with his letter to the Director of the Office of Proceedings, Wilson did not participate in the development of the record in this proceeding. On December 8, 1997, the ALJ held Wilson in default in light of his failure to answer the complaints or to respond to his prehearing order. Nevertheless, a note to the file dated January 5, 1998 indicates that during a telephone conversation with Wilson, the ALJ's law clerk advised him that he remained a named respondent and would continue to receive pleadings, orders and other documents generated in the course of this proceeding.
14 In this regard, McGough claimed that the statute of limitations was "tolled by the nature of the fraud and the complainant's inability to know that he had been victimized by misrepresentations concerning Wilson's alleged methods."
15 Respondents had not previously raised any defenses based on McGough's customer agreement with Iowa Grain.
16 For example, counsel claimed that put and call options were executed for McGough on April 18, but no such trades were mentioned in the fax sent to McGough describing Wilson's purported trades for that date.
17 This colloquy ensued:
Q. And what does paper trading mean to you?
A. This says in real time.
ALJ: Now, just a moment, I want you to tell me. Do you
see that real time and paper trading are two different things?
ALJ: At the time you read this, when you got it, did you see a difference between paper trading and real time trading?
A. I didn't know what paper trading was at this time, you know, at the time of this fax in April of 95. I'm sorry. I didn't.
ALJ: What did you think real time trading meant?
A. Real time was you put real money up . . . .
Tr. at 88-89.
18 When McGough persisted in testifying about going on vacation and being inaccessible by telephone, the ALJ cut him off. Tr. at 46-47. The ALJ was similarly expeditious in dismissing respondents' statute of limitations defense, ruling that McGough filed his complaints in a timely manner. Tr. at 44.
19 Respondents also submitted a letter representing that in July and August, there were at least 150 calls between the Hampton Group and either McGough's house or the hotels at which he stayed on his vacation.
20 Bradford testified that Wilson did use his trading system to actually make some option trades. He explained that Wilson converted signals generated to guide the selection of futures trades to signals that guided the selection of option trades. Tr. at 148, 151.
21 Under questioning from the ALJ, Bradford acknowledged that he had not discussed the difference between hypothetical trading and actual trading with McGough. Tr. at 163. He insisted, however, that the April 27 fax indicated that actual as well as hypothetical trading was occurring. Tr. at 165.
22 Respondents' Exh. 16 is a copy of an April 27 Wilson fax that includes a paragraph of disclosure typed at the bottom of the page. Bradford said that the disclosure paragraph was included in every fax that he sent to McGough.
As discussed below, the faxes described above (included in Complainants' Exh. 8) lacked such disclosure.
23 Kummer maintained his position when shown a copy of an NFA registration application indicating that Wilson was employed by the Hampton Group from December 1994 through October 1995. Kummer acknowledged that he had signed the document as Wilson's sponsor but claimed that he did not recall reviewing the entry about Wilson's employment history. Tr. at 179-81.
24 In addition to their brief, respondents submitted an appendix that included: (1) a new affidavit prepared by respondent Wilson, (2) Complainants' Exh. 8, (3) selected Iowa Grain account statements for an account in the name of "p.G. Wilson, Prof. Corp.," (4) a summary of the trading results in the P.G. Wilson, Prof. Corp. account for the period 11/8/94 to 7/6/95, (5) the post-hearing brief submitted by Bradford and the Hampton Group, and (6) the post-hearing brief submitted by Iowa Grain. Respondents' appeal brief said that the arguments raised in the latter two documents were incorporated by reference.
25 Respondents attempt to incorporate the arguments raised in these posthearing briefs into their appellate brief before the Commission. This practice is not authorized by Commission rules and, in effect, amounts to an evasion of the page limitation imposed by Commission Rule 12.401(d). Accordingly, on our own motion, we strike those portions of respondents' appendix from the record.
26 Because this document is already in the record, there is no value in also including it in an appendix. Consequently, on our motion, we strike the second copy from the record.
27 As discussed below, we conclude that the ALJ did not abuse his discretion in excluding this document from the evidentiary record. We permit the document to remain in the record as a rejected exhibit.
28 Moreover, respondents have failed to address the reliability of the statements reflected in Wilson's affidavit. Given Wilson's failure to appear at the hearing and have his testimony tested by cross-examination, we view the reliability of his statements as, at best, questionable.
29 Moreover, even if only actual trading is considered, an accurate description of the trading results in the P.G. Wilson, Prof. Corp. account is not necessarily an accurate description of the trading system's track record. As the ALJ recognized, an accurate description of the trading system's track record in actual trading would have to reflect the results of all the trades selected by Wilson and actually executed in customer accounts.
30 Respondents claim that a 25% decline in his investment was McGough's trigger point for closing his account and emphasize that the initial account had declined to this level by May 23. Such a decline may amount to notice that Wilson's trading system was not duplicating its previous success, but it does not provide notice that respondents had deceived McGough about the nature of the system's track record. Respondents also emphasize McGough's contentions that Bradford told him that Wilson had a half million to one million dollar account and was doubling his money every six to eight months. In this regard, they contend that the April 27, 1995 fax made it clear that Wilson was not doubling a half million to one million dollar account every six months. The evidence does not support a finding that McGough closely examined this or any other fax in the context of Bradford's specific representations. In any case, notice that an account executive may have exaggerated the extent of past success cannot substitute for notice that the successful track record that Bradford used to promote Wilson's trading system was partially based on trades that might never have been executed in the circumstances that affect trades made in the real world.
31 This distinction was articulated by the concurring judge in Cange v. Stotler, 826 F.2d 581, 596 (7th Cir. 1987) (Easterbrook, J., concurring), who suggested that there was a significant "difference between statutes that forbid waivers and those that do not. The former but not the latter, interdict anticipatory alterations by contract." Id.
32 Respondents' argument also ignores circumstances material to the majority's holding in Cange. The contractual limitations period at issue there applied to a claim raising an implied private right of action under the Act in United States district court. Because there was no express statutory limitations period to apply, there was no statutory provision for the plaintiff to waive. Moreover, the majority opinion suggested that an exculpatory waiver provision signed prior to the initiation of trading would not be enforceable. Cange, 826 F.2d at 594-95. Indeed, at least one court has declined to enforce a contractual provision waiving the two-year limitations period Congress eventually established when it adopted Section 22 of the Act authorizing federal courts to adjudicate certain causes of action under the Act. See Madero v. Refco, Inc., 934 F. Supp. 282 (N.D. Ill. 1996).
33 In the Federal Register release that proposed Commission Rule 180.3, the Commission noted that legislative history indicated that Congress intended that the reparations forum offer a "separate remedy" that supplemented the informal settlement procedure offered by the exchange arbitration forum. The Commission also observed that the agreements then being used by FCMs "may discourage customers from using the Commission's reparations procedures." Arbitration or Other Dispute Settlement Procedures, 41 Fed. Reg. 27526 (July 2, 1976).
34 Such a result would put the benefits of the Commission's reparations program outside the reach of the very people that Congress sought to protect by creating it. Moreover, once the Commission enforced this type of one-sided contractual provision, competitive pressures would likely compel other registrants to adopt similar contractual barriers to the reparations process. As a practical matter, the result would be indistinguishable from a regulatory amendment authorizing pre-dispute waiver of the right to file a reparations claim.
35 As to appropriate safeguards, see Gray v. American Express Co., 743 F.2d 10, 16 (D.C. Circuit 1984) (criticizing the use of "boiler plate language" in a credit card agreement to waive coverage of the Fair Credit Billing Act).
36 We also conclude that this type of waiver is contrary to Congress' intent in creating and maintaining the reparations forum. Indeed, the Commission's prohibition on pre-dispute agreements waiving the right to file a reparations claim was in effect at the time Congress specifically gave the Commission broad authority to promulgate "such rules, regulations, and orders as it deems necessary or appropriate for the efficient and expeditious administration of [Section 14 of the Act]."
37 Generally, these show numerous calls between the Hampton Group and McGough's house from mid-April through July 6. There are no calls from July 7 through July 18, a circumstance generally supportive of McGough's assertion that he was away from home and out of touch. There are, however, three calls to the Hampton Group from a South Dakota number--two on July 13 and one on July 14--when McGough was in South Dakota. There are also at least 150 calls between the Hampton Group and McGough's house from the latter part of July through the cessation of trading in August. This includes 17 calls between the relevant numbers on July 19 alone.
38 Prior to Bradford's testimony, respondents had not raised any challenge to the authenticity of the faxes included in Complainants' Exh. 8, which lacked such disclosure. Indeed, respondents had included identical documents lacking such disclosure as Respondents' Exh. 9. Nevertheless, Bradford claimed that Respondents' Exh. 16 was an example showing his general practice of including hypothetical trade-related disclosure on faxes sent to McGough. The existence of such a general practice is belied by Bradford's failure to submit more than one document consistent with the practice. The existence of the practice is also called into question by Bradford's concession that he never discussed the difference between hypothetical trading and actual trading with McGough. Given these circumstances, we agree with the ALJ's inference that Respondents' Exh. 16 is a "fabrication that was never transmitted to McGough." I.D. at 46,994.
39 In this regard, Bradford acknowledged that he mentioned the success of Wilson's trading system to McGough prior to even speaking with Wilson. Indeed, even at the time of the hearing in this case, Bradford `s understanding of Wilson's trading system was extremely limited.
40 Respondents never specified which trading recommendations that Bradford made to McGough were based on hypothetical trades generated by Wilson's system; which were based on actual trades generated by Wilson's system; and which trades were generated without reference to Wilson's system. Respondents asserted at various points in this proceeding that (1) Wilson traded S&P instruments hypothetically from October 1994 through at least April 1995; (2) Wilson actually traded S&P futures and options and hypothetically traded Eurodollar instruments; (3) Wilson's system generated signals to trade futures and Wilson converted the futures signals to options and actually traded options; and (4) Wilson was engaged in actual and hypothetical trading throughout the time McGough's account remained open, but Bradford based his recommendations on Wilson's actual trading.
41 Rule 4.41(b)(1) states that:
No person may present the performance of any simulated or hypothetical commodity interest account . . . unless such performance is accompanied by one of the following:
(i) The following statement: "Hypothetical or simulated performance results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown;" or
(ii) A statement prescribed pursuant to rules promulgated
by a registered futures association pursuant to section 17(j) of the Act.
(2) If the presentation of such simulated or hypothetical performance is other than oral, the prescribed statement must be prominently disclosed.
See also Commission Advisory, Beware of Websites Selling Commodity Trading Systems that Guarantee High Profits with Minimal Risks (May 1, 2000) (describing how and why "hypothetical trading results can be unreliable").
McGough's claim that the failure to disclose the hypothetical nature of the trading violated NFA disclosure rules as well as Commission rules is not cognizable in reparations.
42 Lee v. Lind-Waldock & Co., [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 28,173 at 50,160 (CFTC June 29, 2000.)
43 Conduct is the "proximate cause" of a loss if the conduct was a "substantial factor" in bringing about the loss and if the loss was a reasonably probable consequence of respondents' conduct. Steen v. Monex Int'l Ltd., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,245 at 38,723 (CFTC Mar. 3, 1992). Misleading conduct is not the 'proximate cause' of a loss if the complainant would have acted no differently had he not been misled. Jakobsen v. Merrill Lynch, Pierce, Fenner & Smith, Inc. [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,812 at 31,392 (CFTC Nov. 21, 1985);Modlin v. Cane, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 28,059 at 49,551 (CFTC Mar. 15, 2000).
44 The Office of Proceedings initially failed to serve the I.D. on Wilson. The error was eventually discovered and Wilson was served on September 30, 1998. Apparently Wilson then retained the attorney who was representing the other respondents. On October 19, 1998, that attorney filed a timely notice of appeal for Wilson. See Proceedings Clerk's Note to File (Sept. 28, 1998); Proceedings Clerk's cover letter to Wilson accompanying the I.D. (Sept. 30, 1998).
45 Complainants argue that Wilson's appeal should be stricken because the ALJ's Notice of Default became final on January 8, 1998 pursuant to Commission Rule 12.22(c). Because the ALJ did not make any damage award at the time he issued his ruling, however, it did not amount to a default order under Rule 12.22(c).
46 NFA's registration records show that Wilson was registered as an associated person sponsored by the Hampton Group for less than a month in late August and early September 1995. McGough had ceased trading both accounts by this time. On August 24, 1995, Wilson filed an application for registration as a CTA, a category that does not require a sponsor. He was approved on December 27, 1995 and remained registered through March 3, 1997.
47 The record also arguably supports an inference that Wilson was indirectly aware that Bradford was using Wilson's system to advise McGough. Two of the faxes in the record contain references to Bradford's "client in Las Vegas." The Hampton Group's telephone records for the period when McGough's account was open show hundreds of calls to and from McGough's number, but only two calls to any other telephone number in the same area code.
48 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.
A party who receives a reparation award may sue to enforce the award if payment is not made within 15 days of the date the order is served by the Proceedings Clerk. Pursuant to Section 14(d) of the Act, 7 U.S.C. § 18(d) (1994), such an action must be filed in a United States District Court. See also 17 C.F.R. § 12.407 (1999).
Pursuant to Section 14(f) of the Act, 7 U.S.C. § 18(f) (1994), a party against whom a reparation award has been made must provide to the Commission, within 15 days of the expiration of the period for compliance with the award, satisfactory evidence that (1) an appeal has been taken to the United States Court of Appeals pursuant to Sections 6(c) and 14(e) of the Act, or (2) payment has been made of the full amount of the award (or any agreed settlement thereof). If the Commission does not receive satisfactory evidence within the appropriate period, such party shall be automatically prohibited from trading on all contract markets and its registration under the Act shall be automatically suspended. Such prohibition and suspension shall remain in effect until such party provides the Commission with satisfactory evidence that payment has been made of the full amount of the award plus interest thereon to the date of payment.