UNITED STATES OF
COMMODITY FUTURES TRADING COMMISSION
|RODNEY S. MODLIN
||CFTC Docket No.
JEFFREY TODD CANE, EVAN THOMAS
TUCKER, III, and AMERICAN FUTURES
|OPINION AND ORDER|
Respondents Jeffrey Todd Cane ("Cane"), Evan Thomas Tucker, III ("Tucker") and American Futures Group, Inc. ("AFG") appeal from an award by an Administrative Law Judge ("ALJ") of $74,308.32 plus interest and costs to complainant Rodney S. Modlin ("Modlin"). The ALJ found that Cane had caused these damages by fraudulently soliciting Modlin to open an AFG account and then lulling complainant to continue trading despite growing losses. He concluded that Cane's conduct violated Section 4b(a) of the Commodity Exchange Act ("CEA" or "Act"), 7 U.S.C. § 6b(a) (1994), and that Tucker and AFG were equally liable for Modlin's damages because they had violated Commission Rule 166.3, 17 C.F.R. § 166.3 (1999), by failing to diligently supervise Cane.
On appeal, respondents challenge the ALJ's credibility assessments and factual determinations as contrary to the record. They also contend that the ALJ committed legal errors in determining causation and calculating prejudgment interest and committed procedural errors that deprived respondents of a fair hearing. Complainant defends the ALJ's findings and conclusions as fully supported by the record and urges us to affirm his award in all respects.
As more fully explained below, based on our
independent review of the record, we affirm the ALJ's findings of liability
but reduce Modlin's damage award to $66,821.72, plus interest and
On May 23, 1997, complainant Modlin filed a reparations complaint pursuant to Section 14(a) of the Act, 7 U.S.C. § 18(a), alleging that respondents Cane, Tucker, and AFG violated provisions of the Act and the Commission's regulations. Counts One and Two charged that Cane fraudulently induced Modlin to open two commodity trading accounts in violation of Sections 4b(a)(i) and (iii) of the Act. Compl. 11-13.1 Counts Three and Four charged that Cane breached his fiduciary duty and churned Modlin's accounts, also in violation of Section 4b(a) of the Act. Id. at 13-15. Count Six charged that Tucker and AFG aided and abetted Cane's violations of the Act in violation of Section 13(a) of the Act, 7 U.S.C. § 13c(a), and failed to supervise Cane in violation of Commission Rule 166.3. Id. at 16-17.2 Modlin sought $74,308.32 in monetary damages, which represents his out-of-pocket losses. Compl. Second Add. at 1.
On August 12, 1997, respondents filed an answer generally denying wrongdoing and asserting a variety of affirmative defenses. On March 2, 1998, respondents filed a Motion to Amend the Answer to add a counterclaim for reasonable legal expenses and attorneys' fees. On March 3, 1998, the ALJ denied respondents' motion without explanation.
After a period of discovery, the ALJ held a hearing in North Carolina on March 18, 1998. Complainant testified on his own behalf and presented the testimony of Goley Bryan Wall ("Wall"), a business partner with knowledge of some of Modlin's dealings with Cane, in support of his allegations. Respondents presented the testimony of Cane and Tucker in support of their defense.
At the hearing, respondents offered into evidence Exhibit R-1, purportedly a transcript of a March 17, 1996 conversation between Cane and Modlin. Tr. 101. Complainant's counsel objected to the admission of Exhibit R-1, not having had the opportunity to compare the transcript with a tape recording. Tr. 101. The ALJ took Exhibit R-1 into evidence, but informed complainant's counsel that he would have a full opportunity to request changes in the transcript after the hearing. Tr. 101.
In questioning Modlin about Exhibit R-1, respondents' counsel began by asking whether he recalled certain parts of the conversation transcribed in that exhibit. Tr. 188. When counsel's questioning turned to Modlin's statements made in his original complaint, however, the ALJ instructed counsel to make this specific line of argument in respondents' post-hearing brief. Tr. 188-89.
On June 8, 1998, Complainant moved to strike Exhibit R-1 from the record, on the ground that the underlying tape cassette had not been produced. On June 19, 1998, the ALJ granted Modlin's motion. On July 1, 1998, the ALJ denied respondents' Request for Reconsideration.
On July 30, 1998, the ALJ issued his initial decision. The ALJ concluded that Modlin proved by a preponderance of the evidence that Cane fraudulently induced Modlin to open two commodity futures accounts and lulled him to continue trading, and that Cane's conduct was the proximate cause of Modlin's $74,308.32 in out-of-pocket losses. Modlin v. Cane, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,392 at 46,803-09 (ALJ July 30, 1998) ("Initial Decision"). The ALJ also concluded that Tucker was aware, or should have been aware, that Cane fraudulently induced Modlin to open two separate accounts at AFG and that Tucker failed to intervene. Id. at 46,809-10. The ALJ held that Tucker and AFG failed to supervise Cane and found them individually and collectively liable for Modlin's out-of-pocket losses. Id.3 The ALJ's conclusions were based, in large part, on his credibility determinations that Modlin and Wall were credible witnesses and that Cane and Tucker were not credible.
In addition to Modlin's out-of-pocket loss of $74,308.32 and the filing fee of $250, the ALJ ordered respondents to pay complainant prejudgment interest at a rate of 5.375%. Although the record showed that Modlin had made several deposits into his account over a seven-month period, the ALJ required respondents to pay interest on the full amount of Modlin's loss from the date of his initial deposit--August 22, 1995. Id. at 46,810. The ALJ held respondents jointly and severally liable for payment of the judgment.
Respondents appealed. On appeal,
respondents make a number of arguments in support of reversing or,
alternatively, modifying the initial decision. Respondents argue, inter
alia, that the ALJ (i) made findings and conclusions that were contrary
to the weight of the evidence; (ii) applied the wrong legal test for
causation; (iii) improperly addressed a number of issues sua
sponte; (iv) denied respondents the right to cross-examine Modlin about
the conversation transcribed in Exhibit R-1;4 (v) erroneously awarded accrued interest on
Modlin's entire out-of-pocket loss from the date of Modlin's initial
investment; and (vi) erred by not permitting respondents to amend their
answer to include a counterclaim for fees and costs. Resp. Br. 1-15.
Many of the parties' disputes on appeal are factual in nature. Respondents, for example, challenge the ALJ's assessment of the nature of the representations Cane made to Modlin, the role Modlin played in selecting the trades made in his account, and the causal link between Cane's representations and Modlin's subsequent losses. Resolution of these questions turns largely on an assessment of the credibility of testimony offered by Modlin and Cane. We begin our analysis of these factual disputes by setting out our general findings of fact. We then proceed to an explanation of our assessment of witness credibility5 and to a review of our findings in light of applicable legal standards.
I. Factual Findings
Based on our independent review of the record, we make the following factual findings.
A. The Parties
During the time period covered by the complaint, Modlin was a North Carolina resident, possessed a high school education, and was self-employed as the owner of a small dump truck company. Tr. 8. Prior to investing with AFG, Modlin had "zero" experience trading commodities and had investment experience limited to a $1,000 investment in a mutual fund. Tr. 8-9, 13, 15-16; Ans. ¶ 2. Although Modlin operated a cattle farm with Wall, Modlin did not follow the cattle or wheat markets prior to investing with AFG. Tr. 51-53, 65, 68.
AFG was a registered futures commission merchant ("FCM") but was not a member of any exchange. Tr. 122, 163. Cane was a registered associated person ("AP") for AFG. Tr. 119-21; Respt's Response to Interrogatories ¶ 1. Cane had approximately one year of experience as a registered commodity broker. Id. For fourteen years prior to that, it is undisputed that Cane worked for international banks, mostly as a financial futures trader with discretion to trade "as [he] s[aw] fit." Tr. 84-85, 131-32, 136-37. Prior to his work as a financial futures trader, Cane worked as a money market and foreign exchange "position clerk," working directly on the trading desk for various banks. Tr. 84. Tucker was the branch manager of AFG's retail office, as well as Cane's supervisor. Tr. 166, 176; Ans. ¶ 15.
B. Cane's Solicitation of Modlin
In July 1995, Modlin became interested in
investing in commodities after seeing and hearing several infomercials,
which discussed "turning $6,000 into $24,000 in three months." Tr. 9.
Modlin responded to one such ad and requested information. Tr. 9, 39.
Modlin began receiving pamphlets, brochures, and phone calls from various
brokers, including Cane. Tr. 9-10, 39; Ans. ¶ 7.
Cane called Modlin after receiving a "lead" from AFG with Modlin's name on it. Tr. 76. Modlin told Cane that he had no experience trading commodities and that "all the information [Modlin] had gained [about trading commodities] was from CNBC." Tr. 13. In his solicitation, Cane stated that "[d]ay trading was . . . his successful method of trading" and that "he would jump into the East River" if he was unable to make Modlin a profit. Tr. 18, 44. Contrary to his claim of having a successful trading strategy, however, Cane did not recall ever closing an account with a profit as a commodity broker, and we infer from Modlin's testimony that he was not informed of this fact. Tr. 158.
Cane further encouraged Modlin to rely on him, with assurances "[t]hat he was [Modlin's] man, that he would hold [Modlin's] hand and teach [Modlin] everything that he knew about trading commodities." Tr. 13, 14. Cane told Modlin that he had 15 years' experience trading commodities and doing "what [Modlin] was interviewing him to do." Tr. 11, 12, 69. Cane's experience far exceeded that of any of the other brokers who had called Modlin. Tr. 10-11.
After reading the account opening documents and speaking with Cane three times, Modlin opened a nondiscretionary account at AFG and, on August 22, 1995, deposited $10,001. Exh. C-1; Tr. 14, 17; Ans. ¶ 17; Compl't's Admissions ¶ B(1). The commission rate for the account was $85 per round-turn trade. Tr. 17. Modlin specifically hired Cane to make trading suggestions and to provide information to help Modlin make trading decisions. Tr. 42-44.6
C. Trading for Modlin's Account and the
Opening of a Second Account
After depositing $10,001 with AFG, Modlin immediately commenced trading. For "most of the trades," Cane provided background information about certain markets, projected market direction, and placed a trade consistent with his recommendation, after obtaining Modlin's preapproval. Tr. 25-26, 42.7
Soon after Modlin began trading, the net equity in his account dropped and Modlin deposited additional funds.8 At some point during Modlin's first month of trading, Cane and Modlin discussed opening a second account. Tr. 32. Cane said that he was planning on moving to an office with Paul Stark ("Stark"), a broker whom Cane called a "wizard." Id. Cane told Modlin that this new relationship would enable Cane to recommend more profitable trades. Id. Cane advised Modlin to open a second account to allow Stark to participate in the trading and requested an initial deposit of $15,000. Id. On September 22, 1995, Modlin deposited $15,000 in a second account at AFG. Exh. C-2; Tr. 32, 65-66.9
Early in the life of the second account, Stark called Modlin to discuss trades. Tr. 33. Initially, trading in that second account was "very light[ ]." Tr. 33; Exh. C-2 (period ending 9/29/95). Stark "disappeared" in October 1995, no more than one month after Modlin opened the second account. Tr. 33. In November 1995, the volume of trading in Modlin's second account increased substantially. Tr. 33; Exh. C-2.
D. The First Margin Call and The Merging of Modlin's Accounts
By November 10, 1995, the low equity in Modlin's first account generated a margin call for $9,500. Tr. 34-35, 152. Although Modlin had approximately $16,000 in his second account, Modlin met the margin call with other funds. Tr. 34-35; Exh. C-1. Cane never suggested that the margin call be met with funds in the second account. Tr. 34-35. One week later, Modlin's balance in his second account was transferred to his first account.10 Exhs. C-1, C-2; Tr. 33-34. Modlin continued to trade, suffer losses, and deposit additional money. Exh. C-1.11
E. Inducement to Continue Trading
In light of the poor results he was obtaining, Modlin, on "lots" of occasions, expressed his concern to Cane about the frequency of the trading in his accounts and the amount of commissions. Tr. 24-25. Cane told Modlin to "stick[ ] with the day trading" and "[the losses] will all come back to you." Tr. 45. Wall attempted to caution Modlin against such heavy in-and-out trading, but Modlin deferred to Cane's "experience in the business" and continued following his directions. Tr. 19-20, 69-70.12
At a point when the net equity in Modlin's account was dropping, Cane also told Modlin about the largest loss--one million dollars--that he had ever incurred for a client. However, Cane emphasized that he was able to recover that loss through additional trading, which "reassured" Modlin and "gave [him] more hope." Tr. 65, 85-88.
Modlin continued to trade until April 1996. In that month, Modlin contacted the National Futures Association ("NFA") and learned, to his surprise, that Cane had been registered as a commodity broker for only 18 months. Tr. 36-38. Modlin ceased trading his AFG account, having incurred out-of-pocket losses totaling $74,310.32. Exhs. C-1, C-2.
F. Lumber and Energy Trades
Modlin conceded that some of his trading losses stemmed from a series of lumber trades that he "absolutely insisted on." Tr. 24.13 Other trading losses resulted from certain energy futures trades. On February 13, 1996, Modlin began building a large short position in light crude and heating oil futures contracts. Exh. C-1. The market turned strongly against Modlin, and by March 18, 1996, many of his short energy futures positions were liquidated at losses totaling $42,193.75, including fees and commissions. Exh. C-1 (2/29/96, 3/29/96).
Shortly thereafter, Cane requested that Modlin cover the resulting $1,902.72 deficit in his account. Modlin replied that he would send in $10,000, enough to meet the margin call and continue trading. Tr. 111-13. On March 21, 1996, Modlin deposited an additional $9,861.00 in his account. Exh. C-1. This deposit covered a $1,902.72 negative account balance, provided $7,958.28 in additional trading funds, and brought Modlin's total investment to $78,263. Exh. C-1; Unnumbered Exhibits (3/18/96-3/21/96 daily account statements). By April 18, 1996, when Modlin ceased trading his AFG account, the net equity in Modlin's account stood at $3,952.68. Exh. C-1.
II. Credibility Determinations
Our factual findings above reflect our determinations--consistent with the ALJ--that Modlin and Wall are credible witnesses and that Cane and Tucker are not. See Initial Decision at 46,800, 46,803. Although respondents make a number of arguments as to why those credibility determinations were erroneous, we find no basis to disturb them.
For example, respondents argue that Modlin's various allegations about his search for a "licensed" broker (Compl. ¶ 5, 6, 7, 9)14 are inconsistent with his admission that he was not aware of a registration requirement at the time of the solicitation (Tr. 11). Resp. Br. at 2-3. At the hearing, however, Modlin stated that the allegations in the complaint were made at a time when he was aware of a registration requirement. Tr. 11-12. We find this explanation to account reasonably for the discrepancy. Learning about the Commission's registration requirement--knowledge that Modlin acquired subsequent to the solicitations--inalterably skewed Modlin's understanding of those earlier solicitations and changed how he might most naturally describe them. Moreover, complainant took the initiative to develop, expose, acknowledge and explain the inconsistency, which related to a key part of his cause of action. Modlin, therefore, voluntarily highlighted an inconsistency that might well have gone without notice. Given these circumstances, we are satisfied that the allegations in Modlin's complaint were initially made in good faith and do not cast doubt on his credibility.
Respondents also claim that Modlin falsely testified that he had "no interest in trading currencies at all," as evidenced by account statements that show that Modlin's first trades included positions in Canadian Dollars. Resp. Br. 4-5; compare Tr. 13 with Exh. C-1. That Modlin's account held Canadian dollar futures, however, is not inconsistent with his lack of interest in financial futures, considering his other allegation that Cane directed most of the trading.
Furthermore, respondents argue that Modlin falsely testified that Cane told him that "day trading" was his successful method of trading and that the key to making money was "sticking with the day trading." Resp. Br. at 5; Tr. 18, 45. Respondents contend that the account statements, which demonstrate that Modlin's positions were largely held for the short term rather than "day traded," refute Modlin's testimony. We disagree. Approximately one-fifth of Modlin's trades were day trades, which is more than enough to make Modlin's testimony consistent with the record. Exhs. C-1, C-2. The extent to which Modlin believed that all of the trading in his accounts were "day trades" reflected his misunderstanding of technical futures trading terminology that is understandable in light of Modlin's relative inexperience in investment matters.
Respondents' attack on Wall's credibility is similarly without merit. Resp. Br. at 9-10. Respondents point only to statements in a letter by Wall (Exh. R-2) that have no relevance to any claim in this case, and on which no testimony was received.
III. Section 4b(a) of the CEA
Modlin complains that Cane fraudulently
solicited him to open two separate accounts and lulled him to continue
trading, in violation of Section 4b(a) of the CEA. Section 4b(a) provides,
in relevant part, that:
It shall be unlawful . . . (2) for any person, in or in connection with any order to make, or the making of, any contract of sale of any commodity for future delivery, made, or to be made, for or on behalf of any other person . . .
(i) to cheat or defraud or attempt to cheat or defraud such other person;
* * *
(iii) willfully to deceive or attempt to deceive such other person by any means whatsoever in regard to any such order or contract or the disposition or execution of any such order or contract. . . .
7 U.S.C. § 6b. For Modlin to succeed on these claims, he must prove by a preponderance of the evidence that Cane (i) made misrepresentation(s); (ii) of material fact; (iii) intentionally or recklessly; (iv) on which Modlin justifiably relied; (v) and which proximately caused Modlin's damages. Bishop v. First Investors Group, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,004 at 44,840-42 (CFTC Mar. 26, 1997); Hammond v. Smith Barney, [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,617 at 36,657 (CFTC Mar. 1, 1990); 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).
A. Misrepresentations of Material Fact
Whether a misrepresentation has been made
depends on the "overall message" and "the common understanding of the
information conveyed" by a solicitation from the perspective of the
reasonable potential investor. Hammond, ¶ 24,617 at 36,657
1. Fraudulent Solicitation to Open First Account
The centerpiece of Cane's solicitation was his claim that his method of trading was "successful" and the "key to making money." Because Cane had never closed an account with a profit, his description of his trading method as "successful" was false and misleading. Tr. 18, 45, 158, 178. Cane made additional representations, all of which served to enhance this main misrepresentation and its deceptive capacity. For example, Cane told Modlin that he "would jump into the East River" if he was unable to generate a profit, bolstering the misrepresentation about his "successful" trading system by conveying an unequivocal degree of confidence in its profit-making potential. Tr. 44.15 Furthermore, Cane enhanced the deceptiveness of the misrepresentation by touting himself as an experienced industry veteran with 15 years of trading experience. Tr. 11, 12, 69, 84-85.16
This central misrepresentation, which
concerned the profitability of Cane's trading system, was material. It is a
rudimentary principle that misrepresentations concerning profit potential
and risks of futures trading are material. In re JCC, [1992-1994
Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,080 at 41,576 n.23
(CFTC May 12, 1994), aff'd, 63 F.3d 1557 (11th Cir.
1995). Similarly, a reasonable investor who hires a broker for, among other
things, trading recommendations (Tr. 43-44) would clearly find it material
to learn that that broker had never closed an account with a profit.
Jakobsen, ¶ 22,812 at 31,392.17
The preponderance of the evidence also establishes that Cane lulled Modlin to continue trading by reinforcing his initial misrepresentations with statements and half-truths designed to convey the impression that losses were temporary and reversible. Lulling "is best understood in the context of the relationship between the activity at issue and preexisting fraudulent activity." Secrest v. Madda Trading Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,627 at 36,698 n.13 (CFTC Sept. 24, 1989). Lulling perpetuates the effect of the initial wrongdoing. For example, where large trading losses might negate the effect of an earlier misrepresentation of profit potential, conduct that induces an investor to continue ignoring those risks constitutes lulling. Swickard, ¶ 22,522 at 30,275; Bishop, ¶ 27,004 at 44,841-42.
After fraudulently soliciting Modlin to open an account, the net equity in Modlin's account began to decrease. Because of these losses, Modlin expressed his concerns about the frequency of the trading and the commissions he was paying. Tr. 24-25. Rather than explain the high degree of risk involved with futures trading, Cane told Modlin to "stick with the day trading" and "[the losses] will all come back to you." Tr. 45. Through these statements, Cane perpetuated the initial misrepresentations about the profit potential of his trading system that he had made when soliciting Modlin to open an account.
Similarly, at a time when the net equity in Modlin's account was decreasing, Cane downplayed the risks involved by conveying a personal anecdote about how he was able to recover a $1 million loss in an account of one of his clients. Cane's tale falsely suggested that Modlin's large futures trading losses were only temporary setbacks that Cane could help Modlin overcome. Tr. 65, 85-88. Cane's unbalanced reassurance was a material misrepresentation of the risks involved. Cf. Heilman v. First Nat'l Monetary Corp., [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,207 at 32,570 (CFTC Aug. 14, 1986) (broker repeatedly urged customer to be patient with futures positions because of broker's confidence that prices would increase).18
Cane's solicitation of Modlin to open a second account reflected an additional effort to lull complainant. Cane proposed opening a second account using a trading "wizard" (Stark) to achieve more successful trading results. These statements reflect Cane's effort to distract Modlin from the losses developing in the first account and from discovering Cane's misrepresentations about his "successful" trading system.
Cane's misrepresentation that his day-trading style of trading was "successful" was intentional because he knew that he had never closed an account at a profit. Tr. 158. Cane, a broker with lengthy experience, certainly understood that his various claims and distractions concerning profit potential and risks of trading amounted to misrepresentations and lulling. Furthermore, Cane knew that Modlin had "zero" experience trading commodities and would not be able to detect the misrepresentations. Tr. 13; Exh. C-3.
C. Justifiable Reliance/Proximate Cause
The preponderance of the evidence demonstrates that, prior to March 18, 1996, Modlin justifiably relied on Cane's misrepresentations and that those misrepresentations proximately caused most of the $74,310.32 in losses that Modlin suffered.
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), aff'd, 986 F.2d 1422 (6th Cir. 1993). Misleading conduct is not the "proximate cause" of a loss if the complainant would have acted no differently had he not been misled. Jakobsen, ¶ 22,812 at 31,392.19
Modlin was unsophisticated in financial matters and had a limited understanding about futures trading, obtained exclusively from infomercials that were themselves misleading. Tr. 8-9, 13, 15-16. Cane fostered a relationship with Modlin that was quite personal, stating that "he was [Modlin's] man and would hold [Modlin's] hand," inviting Modlin to New York and discussing topics of a personal nature. Tr. 13-14, 33, 85. In lulling Modlin, Cane sought to conceal, and perpetuate, his initial misrepresentations. Indeed, Modlin testified to the high level of confidence he placed in Cane's expert opinions, refusing to follow Wall's advice against such frequent trading in deference to Cane's "experience in the business." Tr. 19-20, 69-70. These factors demonstrate, therefore, that Modlin justifiably relied on Cane and that Cane's misrepresentations were a substantial factor in Modlin's out-of-pocket losses. See Jakobsen, ¶ 22,812 at 31,393 n.1 (describing relevant factors of a justifiable reliance analysis).
Moreover, much of Modlin's losses--including his commissions--were a reasonably foreseeable consequence of Cane's conduct. Cane knew that Modlin had no futures experience and extremely limited investment experience. Therefore, Cane could reasonably foresee that Modlin would not be able to assess Cane's solicitation or detect the fraudulent misrepresentations that he would make. In addition, Cane portrayed himself as an expert in the field and encouraged Modlin to rely on him. In light of all of these factors, it is reasonably foreseeable that Modlin would rely on Cane's various misrepresentations to open a futures account and continue trading. Modlin's resulting losses also were reasonably foreseeable: not only did Cane know that futures trading is an inherently risky activity, he knew that he had never closed a customer account with a profit.
Respondents' argument that Modlin would have opened an account and suffered losses with another broker, even in the absence of Cane's misrepresentations, is not persuasive. Resp. Br. 2. That Modlin may have been interested in opening an account prior to speaking with Cane does not imply that other brokers would have similarly misrepresented the profitability of their approaches to trading.
Respondents similarly contend that Modlin would have opened an account with Cane, even in the absence of any misrepresentations. The gist of respondents' argument is that Modlin's claim that he would not have opened an account at AFG had he known about the nature and length of Cane's experience is inconsistent with how a reasonable investor would have acted.20 Resp. Br. 4-5. We disagree. Modlin's claim--that he was searching for a broker who possessed experience doing exactly what that broker would, in fact, be doing for Modlin--is a perfectly reasonable approach to searching for a broker. See Tr. 12. In any event, respondents' argument is irrelevant. The basis for our finding that Cane fraudulently solicited Modlin to open an account is Cane's misrepresentation of the profitability of his trading system. As to that point, respondents do not claim that Modlin would have opened an account with Cane had he known that Cane, in fact, did not have a successful trading system.21
Nevertheless, we find that Cane's fraudulent conduct was not a substantial factor in causing $4,005.60 of the losses that Modlin incurred after March 18, 1996. As explained above, by March 18, 1996, many of Modlin's short energy futures positions were liquidated at losses of $42,193.75 (including fees and commissions), more than half of his total loss. Exh. C-1 (2/29/96, 3/29/96). Relative to any of his previous losses in the account, these $42,193.75 in losses were staggering, far in excess of the $25,000 that Modlin listed on his account application as his risk capital. Exh. C-3. These losses were large enough to prevent Modlin from continuing to rely on Cane's misrepresentations of profit potential and risk of loss, or on any of the related lulling conduct. Therefore, when Modlin decided to invest an additional $7,958.28 on March 21, 1996 (of which $4,005.60 was subsequently lost), he did so with full appreciation of Cane's approach to trading and the risks involved.
We disagree with respondents' argument, however, that Modlin was independently responsible for the all of the trading losses involved with certain energy futures contracts. Although respondents claim (Resp. Br. at 7, 13) that Modlin testified that he "made" the energy trades, we read Modlin's testimony differently. Modlin testified that he recalls stating that the "oil trades were [mine.]" Tr. 188. We find this testimony to be indicative of the fact that Modlin approved those trades based on Cane's recommendation, rather than an admission that he independently initiated the unsuccessful energy futures trades. For the same reason, we are not troubled by Modlin's statement in a recorded conversation between Modlin and Cane held on or after March 19, 1996-after the point when Modlin had incurred $42,193.75 in trading losses-that Modlin "put . . . on" the energy positions. Exh. R-3, at 3-4. Moreover, to whatever extent that transcript might appear to show that Modlin independently chose to maintain losing energy positions, it is not reliable evidence because it was not Cane's routine practice to tape record his clients. Tr. 107-08.22
We conclude that Modlin also did not rely on Cane's misrepresentations when making the lumber trades. Although Modlin explained that Cane directed the trading for the account, Modlin "absolutely insisted on" certain lumber trades, which led to $3,483 in losses, including fees and commissions. Tr. 24; Exhs. C-1, C-2.
Respondents argue that the ALJ erroneously denied their motion to amend their answer to add a counterclaim and that his decision demonstrates bias. Resp. Br. at 12. Respondents' counterclaim sought reasonable attorney's fees, based on contractual provisions in the AFG customer agreement. See Motion to Amend Answer, at Attachment (¶¶ 6, 15).
Even if the ALJ incorrectly denied respondents' motion, such a counterclaim would be unsuccessful. The circumstances in which Paragraph 15 of the AFG customer agreement apply are not present in this case.23 Moreover, to enforce the indemnification provision in Paragraph 6 would be counter to public policy. Paragraph 6 provides that "Customer shall indemnify and hold harmless AFG, [and]. . . its . . . agents from and against all losses, damages and expenses (including reasonable attorney's fees) arising out of, or directly or indirectly resulting from . . . any order entered . . . for . . . Customer's accounts." As written, the provision would allow respondents to be insured against their own reckless or willful misconduct and is, therefore, too broad to be enforceable. Globus v. Law Research Service, Inc., 418 F.2d 1276, 1288-89 (2d Cir. 1969); Pal v. Reifler Trading Corp., [1996-1998 Transfer Binder] Comm. Fut. Law. Rep. (CCH) ¶ 27,237 & n.5 (CFTC Feb. 2, 1998).
V. Prejudgment Interest
Respondents contend that the ALJ's award of damages incorrectly accrued prejudgment interest from the date of Modlin's first investment, rather than apportioning such interest from each separate date of investment. As a general rule, the decision to grant prejudgment interest is entrusted to the discretion of the presiding officer, although such an award in reparations cases is the rule rather than the exception. Leftwich v. Rufenacht, Bromagen & Hertz, Inc., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,044 at 34,597 (CFTC Dec. 9, 1987); Newman v. Bache Halsey Stuart Shields, Inc., [1984-86 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,432 at 29,919 n.4 (CFTC Nov. 19, 1984). In general, we think that the zone of the presiding officer's discretion also extends to the method a presiding officer uses to determine the starting date for accruing prejudgment interest.
Generally, we will not find an abuse of discretion merely because the ALJ's method is inexact or reflects practical factors to simplify reasonably the calculation of damages. Cf. Chandler v. Bombardier Capital, Inc., 44 F.3d 80, 84 (2d Cir. 1994) (affirming a method of calculating prejudgment interest on a backpay award that "achieved a fair figure for the interest, [and] avoid[ed] the need for numerous calculations"). As long as the ALJ's award of prejudgment interest reflects an effort to compensate an investor for the lost time value of money, rather than an attempt to punish, the ALJ is within his discretion. In re Milwaukee Cheese Wisconsin, Inc., 112 F.3d 845, 849 (7th Cir. 1997) ("Compensation deferred is compensation reduced by the time value of money . . . . [P]rejudgment interest is an ingredient of full compensation."); Raybestos Products Co. v. Younger, 54 F.3d 1234, 1247 (7th Cir. 1995) ("prejudgment interest serve[s] to fully compensate the injured, but not to penalize the party causing injury").
In light of the specific facts and circumstances of this case, we find that the ALJ abused his discretion in accruing prejudgment interest from the date of Modlin's first investment. Throughout the duration of his account, Modlin made investments in varying amounts at different dates.24 Accruing prejudgment interest on the entire award from the date of the first investment does more than compensate Modlin for the time value of money: it gives Modlin a windfall.
For reasons of practicality, however, an
exact accrual of prejudgment interest from each specific date of investment
is not necessary to compensate Modlin fairly. Based on the above
discussion, Modlin is entitled to an award of $66,821.72. Prejudgment
interest shall accrue on that entire amount from November 14, 1995, the
date on which Modlin had deposited exactly half of that amount. Accruing
prejudgment interest in this way permits a fair and practical approach to
compensating Modlin for the lost time value of his investment. Cf.
Newman, ¶ 22,432 at 29,919 (declining to adopt an
administratively "complicated" and "burdensome" approach to calculating
interest); Piskur v. International Precious Metals Corp., [1984-1986
Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,493 at 30,190-91 (CFTC
Jan. 2, 1985) (using a practical, inexact approach to accruing prejudgment
We affirm the ALJ's conclusions that Cane fraudulently solicited Modlin to open and continue trading futures accounts, in violation of Section 4b(a) of the CEA. In addition, we affirm the ALJ's conclusion that AFG and Tucker failed to supervise Cane, in violation of Commission Rule 166.3, and that they are individually and collectively liable for Modlin's losses.25 Pursuant to Section 2(a)(1)(A)(iii) of the Act, 7 U.S.C. § 4, AFG also is liable for Cane's and Tucker's violations of the Act.
In light of our findings and conclusions, we modify the ALJ's award of damages. We order respondents to pay Modlin $66,821.72, plus interest at the rate of 5.375% accrued from November 14, 1995, plus the $250 filing fee. Respondents are jointly and severally liable for payment of this judgment.26
IT IS SO ORDERED.
By the Commission (Chairman RAINER,
Commissioners HOLUM, SPEARS and NEWSOME) (Commissioner ERICKSON, concurring
in part and dissenting in part).
Jean A. Webb
Secretary of the Commission
Commodity Futures Trading Commission
Dated: March 15, 2000
OPINION OF COMMISSIONER ERICKSON
I concur in part and dissent in part from the majority's opinion. I generally concur with the majority's finding of liability in this case, but believe that the majority improperly performs a de novo review of the ALJ's credibility findings. I also disagree with the majority's calculation of damages and interest. Rather than second-guess the judgment of the ALJ in matters typically left to his discretion, I would simply and summarily affirm the initial decision of the ALJ.
The majority appears to undertake a de novo review of the ALJ's determinations of credibility. With respect to determinations of witness credibility, absent clear error, the Commission generally defers to the findings of its ALJs. In re Guttman, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. ¶ 27,337 at 46,561(CFTC Apr. 27, 1998) (citing In re Mayer, 1998 WL 80513 at *31 n.63 (CFTC Feb. 25, 1998)). De novo review is only appropriate in exceptional cases. For example, the Commission has held that where an ALJ's credibility findings are "strongly contradicted by other compelling evidence, and the issue to be decided involves derivative inferences rather than testimonial inferences, the Commission will review de novo the inferences to be drawn from the record". In re Elliott, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. ¶ 27,243 at 46,007 (CFTC Feb. 3, 1998).
In the present case, the ALJ found Modlin's testimony "to be straightforward, consistent with the evidence, credible and reliable." Initial Decision at 46,803. Conversely, the ALJ generally found Respondents Cane and Tucker "neither credible nor reliable in light of all the evidence and testimony." Id. The majority, moreover, states that it agrees with the ALJ's credibility assessments. Majority Opinion at 11. Under these circumstances, I see no reason to conduct an independent assessment of the ALJ's determinations and subscribe to Commission precedent which instructs us to defer to the ALJ's findings on this issue.
Damages & Interest Calculations
Absent an independent determination of abuse of discretion by the ALJ, failure to apply recognized standards, or clear error, the calculations of damages and interest should be left intact. Without intending to do so, I believe the majority opinion risks establishing a de facto standard for both the calculation of damages in cases where there is a finding of lulling and for the calculation of interest.
The Commission's majority opinion examines the
principle of lulling:
Lulling "is best understood in the context of the relationship between the activity at issue and preexisting fraudulent activity." Secrest v. Madda Trading Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,627 at 36,698 n.13 (CFTC Sept. 24, 1989). Lulling perpetuates the effect of the initial wrongdoing. For example, where large trading losses might negate the effect of an earlier misrepresentation of profit potential, conduct that induces an investor to continue ignoring those risks constitutes lulling. Swickard, ¶22,522 at 30,275; Bishop, ¶27,004 at 44,841-42.
Majority Opinion at 15.
The majority correctly observes that "[t]he preponderance of the evidence also establishes that Cane lulled Modlin to continue trading by reinforcing his initial misrepresentations with statements and half-truths designed to convey the impression that losses were temporary and reversible." Id. Despite this determination, the majority next attempts to draw a line beyond which a victim of lulling is on notice that the Commission will no longer award damages for out-of-pocket losses. The majority appears to suggest that an appropriate standard to apply is when "losses ... [are] ... far in excess of ...[the amount] ... listed on [a customer's] account application as his risk capital." Majority Opinion at 20.
Making a determination that a customer was effectively lulled is significant. Once such a determination is made, it is exceptionally difficult to determine when a customer should have realized that he or she was being mislead. Such a determination is necessarily fact- and case-specific, and I do not doubt that there are cases where a customer receives the type of information that should effectively put him or her on notice regarding fraudulent or misleading conduct. However, I do not think the majority's opinion provides a compelling argument for making such a determination in the case of Mr. Modlin. Moreover, I do not think the majority's analysis in this case is at all instructive for future cases. I would affirm the ALJ's determination of damages.
Interest calculations can be similarly vexing. Again,
the Commission risks having its formula embraced as a standard that, while
facially fair in the pending matter, could prove to be extraordinarily
unfair in other cases. Certainly, in those cases where fifty percent of
funds deposited into a trading account were received at or close to the
middle of the trading period in question, the formula embraced by the
majority would achieve a relatively fair result. However, in those cases
where half of the funds were on deposit very early or very late in the
trading period in question, the relative fairness of the formula is called
into question. The majority recognizes that calculation of interest can be
an inexact process and can reasonably reflect practical considerations.
Majority Opinion at 23. Because I believe the ALJ's calculation reflected
such an equitable and reasoned approach, I am unwilling to find error in
his determination of interest and would affirm his determination.
1 "Compl. ___," "Compl. Second Add. ___," and "Ans. ___" refer to the Complaint, the Second Addendum to the Complaint, and the Answer. "Compl't's Admissions ___" refers to Complainant's Answers to Interrogatories and Admissions. "Tr. ___" refers to the hearing transcript. "Exh. ___" refers to the exhibits. "Resp. Br. ___" refers to the Appeal Brief of Respondents.
2 Modlin also charged a violation of Section 4o of the Act, 7 U.S.C. § 6o, which applies to categories of professionals not involved in this case, and abandoned a charge of unauthorized trading. See Compl. 12-13, 15-16; Compl. Second Add.; Tr. 56-57.
3 In light of these conclusions, the ALJ did "not find it necessary to address the Complainant's claims" of churning, breach of fiduciary duty, or aiding and abetting. Id.
4 On March 12, 1999, respondents sought leave to introduce a tape cassette that contains the conversation transcribed in Exh. R-1. On March 17, 1999, complainant filed a letter in opposition to respondents' application.
5 As more fully explained below, our factual findings are based largely on our determinations that Modlin and Wall are credible witnesses and that Cane and Tucker are not.
6 On his application, Modlin indicated that his risk capital was $25,000, that his investment experience was limited to a $1,000 mutual fund investment, that his annual income was between $50,000 and $75,000, and that his net worth was less than $50,000. Exh. C-3. After calling Modlin to discuss this, Cane changed the application document to indicate that Modlin's net worth was instead between $100,000 and $250,000. Exh. C-3; Tr. 139.
7 Occasionally, Cane would ask Modlin to research certain recommendations further. Tr. 26.
8 Modlin commenced trading on August 22, 1995 with $10,001. Nine days later, the net equity had dropped to $7,509.21. By September 19, 1995, the net equity had dropped to $7,054.20. On September 21, 1995, Modlin deposited an additional $5,000 in his first account. Exh. C-1; Unnumbered Exhibits (daily account statements).
9 Cane also invited Modlin to New York for a presentation about Stark's trading methodology. Tr. 33. After investing the initial $15,000 in the second account, Modlin traveled to New York to meet Cane and Stark, but did not understand Stark's presentation. Tr. 59-60, 66.
10 In light of Stark's "disappear[ance]," Modlin believed that there was no need to keep a second account. Tr. 34.
11 By November 13, 1995, the net equity in Modlin's first account fell to $6,861.28. On November 14, 1995, Modlin deposited $9,501 to cover the margin call discussed above, bringing his total investment in his first account to $24,502. On November 17, 1995, Modlin transferred the balance of his second account --in which Modlin had deposited $15,000--to his first account, bringing his total investment in his first account to $39,502 and the net equity to $25,058.83. Thereafter, the net equity in Modlin's account dropped, to $24,968.01 on November 30, 1995, to $22,064.30 on December 29, 1995, and to $8,033.88 on January 12, 1996. On January 16, 1996, Modlin deposited another $20,000, bringing his total deposit to $59,502 and his net equity to $25,547.48. The net equity continued to drop, to $23,709.28 on February 1, 1996, and to $20,351.18 on March 11, 1996. On March 15, 1996, Modlin invested $8,900, bringing his total investment to $68,402, although the net equity dropped to $11,913.18 by day's end. By March 18, 1996, all of Modlin's positions had been liquidated, leaving a $1,902.72 debit balance. Exh. C-1, Unnumbered Exhibits (daily account statements).
12 Modlin chose not to approve a small number of Cane's recommendations to liquidate open positions. Tr. 24-25, 26.
13 These lumber trades generated net losses of $3,483.00, including fees and commissions. Exhs. C-1 (10/31/95 to 12/29/95), C-2 (10/31/95, 11/30/95).
14 Complainant alleged in the complaint that he "interviewed . . . potential brokers explaining to each that he . . . was looking to engage as a broker, a person with long experience as a licensed commodity broker"; that "[a]ll of the brokers who called had, at most, three years of experience as a lisensed [sic] commodity brokers [sic]"; that Cane initially "represented himself as a Registered Commodity Broker employed by American"; that Cane "intentionally [led] Complainant to believe that [Cane's] experience was as a licensed commodity broker and was Cane's selling point." Compl. ¶ 5, 6, 7, 9.
15 The "East River" comment also misrepresented commodity futures trading as likely to be profitable.
16 Cane's touting of his 15 years experience also amounted to a misleading half-truth, in light of his failure to convey his poor track record trading futures. Swickard v. A.G. Edwards & Sons, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,522 at 30,275 (CFTC Mar. 7, 1985) (failure to disclose a track record can make claims of expertise misleading).
17 In light of our conclusion that, taken as a whole, Cane's solicitation of Modlin to open a futures trading account amounted to a misrepresentation of the profit potential of trading with Cane, we do not find it necessary to address whether, standing alone, misrepresentations of the length and nature of Cane's trading experience could be the basis of an award, or respondents' argument (Resp. Br. at 7-8) that the ALJ improperly found sua sponte that Cane misrepresented his trading experience.
18 Although Modlin read the risk disclosure statements and testified that Cane "discuss[ed] . . . the risks" (Tr. 17; Complainant's Admissions ¶ B(1)), the overall message about the risks of futures trading deceived Modlin. Complainant's Admissions ¶ B(2); cf. Hammond, ¶ 24,617 at 36,657.
19 Respondents incorrectly contend that causation can be proved only by showing that Cane had "de facto control" over the account and that trades made under that control were contrary to the complainant's investment goals. Resp. Br. at 15. Respondents articulate the basis of causation in a churning claim, a claim which the ALJ declined to reach, as do we. Morris v. CFTC, 980 F.2d 1289, 1295 (9th Cir. 1992).
20 In support of this argument, respondents contend that (i) Cane's actual experience was relevant and far exceeded that of the other brokers with whom Modlin spoke; and (ii) an unsophisticated investor like Modlin would not have differentiated between retail, non-financial futures experience and experience trading financial futures for banks. Resp. Br. 4-5.
21 We also disagree with respondents' argument that evidence that Modlin preapproved every trade demonstrates that Modlin himself caused his trading losses. Resp. Br. at 14-15. Modlin's preapproval--as well as his "participat[ion]" in making trading decisions--was of little significance, because "most of the trades" were made consistent with Cane's recommendations. Tr. 25-26, 31, 42.
22 Respondents argue that the ALJ erred in striking from the record a second transcript (Exh. R-1), which purportedly reflects that Modlin himself directed all of his unsuccessful energy trades. Pointing to Modlin's testimony that "I've heard the first part of the tape," respondents contend that complainant's motion to strike Exhibit R-1 falsely represented that he had not received from respondents a copy of the underlying tape cassette with which to compare Exh. R-1. Resp. Br. at 10-12.
Respondents easily could have cleared this evidentiary hurdle by producing a copy of the cassette to the ALJ and the complainant in response to the motion to strike. In light of respondents' failure to respond to Modlin's motion to strike and the absence of the underlying tape cassette, the ALJ made no error in striking Exhibit R-1. Although respondents finally submitted the underlying cassette eight months after the complainant's motion to strike, they offer no reasonable grounds for failing to adduce this evidence earlier. Letter dated Mar. 12, 1999 from Gary M. Sinclair; see Commission Rule 12.405, 17 C.F.R. § 12.405. Modlin's testimony that he had heard part of a tape recording (Tr. 188) does not demonstrate that he had received and heard the underlying cassette for Exhibit R-1 because he did not unambiguously refer to the conversation transcribed in that exhibit, as opposed to Exhibit R-3. See Exh. R-3 at 3-4. In any event, even if Exh. R-1 were admissible, we would deem it to be unreliable evidence for the reasons stated in the text.
Respondents similarly argue that the ALJ improperly cut off their cross examination of Modlin concerning the conversation transcribed in Exh. R-1. Resp. Br. 10-12. We disagree. Respondents' line of questioning attempted to highlight inconsistencies between statements already in the record and statements already transcribed. Tr. 188. For purposes of attempting to impeach Modlin's credibility in this way, there was no need for respondents to elicit testimony. The ALJ had the discretion to curtail this type of inefficient questioning. Cf. Guttman v. CFTC, 197 F.3d 33, 38 (2d Cir. 1999). Moreover, the ALJ's action did not prevent respondents from attempting to draw out relevant testimony from Modlin and then impeach that testimony with the use of R-1.
In light of these conclusions, we also find respondents' allegations of bias to be meritless. Resp. Br. at 12.
23 Paragraph 15 concerns the reasonable attorney's fees for collecting "indebtedness at any time owing from Customer to AFG." The record reflects that no such indebtedness exists.
24 Modlin deposited $10,001 on August 22, 1995; $5,000 on September 21, 1995; $15,000 on September 22, 1995; $9,501 on November 14, 1995; $20,000 on January 16, 1996; $8,900 on March 15, 1996; and $9,861 on March 21, 1996.
25 Respondents did not present any issues in their statement of issues pertaining to Tucker's and AFG's failure to supervise. We, therefore, treat respondents' incorporated arguments pertaining to those issues as waived and affirm the ALJ's findings of liability. Commission Rule 12.401(f), 17 C.F.R. § 12.401(f). In light of our affirmance, we do not address Modlin's claim of aiding and abetting liability.
Because we affirm the ALJ's conclusion that Cane fraudulently solicited and lulled Modlin, we also see no need to address Modlin's alternate claims of breach of fiduciary duty and churning. Moreover, we do not address in detail respondents' arguments that the ALJ impermissibly made various findings and conclusions "sua sponte." Resp. Br. at 8-9. To the extent our findings and conclusions differ from the ALJ's, these arguments are moot; otherwise, we find these arguments to have no merit.
26 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.