UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
LAWRENCE L. SOMMERFELD
JOHN JOSEPH AIELLO, DEARBORN
CAPITAL MANAGEMENT, LTD., and
|CFTC Docket No. 98-R009|
HANS and LISA SCHNEIDER
JOHN JOSEPH AIELLO, JOHN
FREDERICK MILES, DEARBORN
CAPITAL MANAGEMENT, LTD. and
CFTC Docket No. 98-R075
OPINION AND ORDER
Complainants Hans and Lisa Schneider (the "Schneiders") and Lawrence Sommerfeld ("Sommerfeld") appeal from an Initial Decision ("I.D.") that dismissed their complaints due to a failure of proof. They raise challenges to the Administrative Law Judge's ("ALJ") liability and damages analysis. Respondents oppose the appeals and urge us to affirm the result of the ALJ's decision.
As explained below, we conclude that the
ALJ erred in basing some of his findings on the testimony of
respondents' witnesses. Nevertheless, because the record supports
dismissal of the complaints, we affirm the result of the ALJ's
The facts and circumstances material to the disputes in these consolidated cases share common elements. Both the Schneiders and Sommerfeld became members of the Bulls and Bears Club (the "Club") prior to opening accounts with respondent Refco, Inc. ("Refco") through respondent Dearborn Capital Management ("Dearborn").1 Complainants opened their Refco accounts based on information they learned at the Club, obtained Refco's account-opening documents at the Club, returned the completed account-opening documents to a Club member for transmittal to Refco, and often gave their trading instructions to a Club member for transmittal to Refco.
During the time at issue, 45 Club members maintained accounts at Refco. Refco charged all Club members its lowest commission rate.2 Because Club members openly discussed their trading, it was common knowledge that most if not all Club members with Refco accounts were trading strangle positions in options.3 Respondent John Frederick Miles ("Miles") was the senior account manager responsible for all the accounts that Club members maintained with Refco.4 During March 1997, Miles sent two other Refco APs to visit the Club's Rancho Mirage, California location.5 During their visit, respondent John Joseph Aiello ("Aiello") and Emil Van Essen ("Van Essen") arranged a dinner and breakfast for Club members.6
Club member Sy Gaiber ("Gaiber") played a major role in educating fellow Club members about strangle trading.7 He frequently discussed strangle trading at seminars that the Club offered on Wednesdays. During the seminars, Gaiber discussed how strangle trading worked and noted that when a trader sold options, there was unlimited risk. When asked, Gaiber would also offer his opinion about the specific strangle positions that a Club member executed.
Club member Stanley Rhea ("Rhea") was also knowledgeable about strangle trading. He prepared a document that indicated strangle selling could produce a monthly income substantial enough to pay living expenses.8 Rhea referred fellow Club members to Refco and provided assistance when Club members requested help completing Refco's account-opening forms. Rhea also played a role in the strangle trades that Club members actually executed. At least one Club member executed a written power of attorney granting Rhea discretion over the trading in his account.
Club member Judy Johnson ("Johnson") was not particularly knowledgeable about strangle trading. Nevertheless, several Club members executed written powers of attorney granting Johnson discretion over trading in their accounts. Johnson executed a letter stating that she was exempt from registration with the Commission as a CTA because she was not advising more than 15 clients. Johnson took this step based on Miles's advice.
Johnson had frequent contact with Refco employees. On some occasions, she telephoned Refco to obtain account-opening kits. Eventually, she built up a supply of the account-opening kits that she kept in a drawer at the Club. Johnson provided one of the kits to Club members who wished to open a Refco account. She also assisted Club members when they filled out the forms.
Johnson also played a central role in
communicating Club members' trading instructions to Refco. Club
members often determined their trading instructions after a discussion
among a group of members trading strangle positions. Club members in
the group would then communicate their instructions to Johnson, and
Johnson would telephone Refco to communicate the orders. Sometimes
this process resulted in bunched orders - a single order for multiple
positions that represented a combination of the individual orders made
by the Club members in the group.9
Sommerfeld opened an individual trading account with Refco in March 1997.10 During the account-opening process, he signed an acknowledgment that he had read and understood Commission-required disclosure documents. Sommerfeld traded strangle positions in the account until he closed it in June 1997. He deposited $50,000 to margin trading in March. By the end of the month, the liquidation value of his account had fallen below $45,400. Sommerfeld deposited an additional $100,000 in April but, once again, by the end of the month the liquidation value of his account was less than his total deposit. The liquidation value of Sommerfeld's account declined to about $103,600 by the end of May, and stood at about $76,400 when complainant closed his account in June.
The Schneiders also opened their Refco
account in March 1997. They traded strangle positions during March,
April, and May.11 By the end of
March, the liquidation value of the account had fallen almost $9,000
below their $50,000 deposit. The Schneiders deposited an additional
$430,000 into their account in April, but by the end of the month the
liquidation value of their account was less than their total deposit.
On May 5, 1997, the account lost over $52,200 on the liquidation of a
10-contract call position. By the end of May, the account had lost
more than $323,100 on option transactions.
During April 1997, Refco wrote a letter to the National Futures Association ("NFA") noting that the Club was not registered and requesting that NFA review a Club brochure and further investigate this company.12 In late June 1997, the Club's former general manager, Thomas Dullien, wrote a letter to NFA claiming that "[i]n an effort to attract more members quickly through the lure of fast money, Mr. Sy Gaiber along with [Gaiber's fiancée] are giving investment advice on how to trade S&Ps." Dullien also reported that Gaiber was being paid 20 percent of the gains earned by a pool that included 45 Club members. Shortly thereafter, NFA notified Refco of Dullien's allegations.
By letter dated July 31, 1997, Refco
informed Gaiber that it would no longer permit him to exercise
discretionary trading authority over accounts maintained at
Refco.13 Refco placed the covered
accounts on a liquidation-only status until Gaiber's discretion
was revoked. It did not, however, inform its customers of the
allegations against Gaiber reported by NFA.
Sommerfeld filed a reparations complaint seeking more than $73,500 in damages in October 1997. The Schneiders filed a similar reparations complaint seeking more than $346,000 in damages in January 1998.14 Both complaints raised a variety of liability theories. The theories material to this appeal include two theories of direct liability and one theory of aiding and abetting liability. Specifically, the complaints alleged that respondents were directly liable for failing to: (1) disclose facts material to complainants' decision to open an account and trade strangles, and (2) furnish the risk disclosure documents required by Commission Rules 1.55 and 33.7. The complaints also alleged that respondents aided and abetted the Club's operation of an IB business without the registration required by Section 4d of the Act.
Respondents' joint answers denied all
allegations of wrongdoing. They claimed that they had fulfilled all
their disclosure obligations under the Act and Commission regulations,
and noted that each of the complainants had received the required risk
disclosure statements and executed an appropriate acknowledgment.
Respondents also emphasized that they had specifically discussed the
risks associated with options trading and with trading strangles in
both individual and group meetings with Club members. Respondents
argued that because complainants' aiding and abetting theory
focused on an alleged registration violation, it was not the proper
subject of a reparations complaint. In this regard, they alleged that
the Club's failure to register was not the proximate cause of
The parties commenced the discovery process in December 1997. Both parties raised objections to some of the other party's discovery requests. Complainants filed a motion to compel in February 1998. A letter in the record indicates that the ALJ's law clerk contacted complainants' counsel and indicated that the judge wanted counsel for the parties to try to resolve the discovery dispute informally. Respondents eventually supplemented their discovery responses three times. One of respondents' submissions refers to a March 4 oral ruling by the ALJ on complainants' motion to compel. The record, however, does not describe the ruling or the ALJ's rationale for not issuing a written decision.15 The record shows that complainants voluntarily supplemented their own discovery responses.
Respondents filed a prehearing memorandum
in April 1998. For reasons not clearly explained on the record,
complainants did not submit a prehearing memorandum.
The ALJ conducted a four-day hearing in San Diego, California in May 1998. He held the fifth day of the hearing at the home of complainant Sommerfeld.16 Five of the six complainants in this consolidated proceeding testified in support of their claims. Complainants also presented the testimony of Debra Michel, a Club employee who filed a separate complaint against respondents. Respondents Miles and Aiello testified for the defense. In addition, respondents sponsored the testimony of Van Essen, Gaiber, Rhea, and Johnson. Finally, respondents presented the testimony of Mickey McGuire ("McGuire") and Doug Wall ("Wall"). Both were former Club members who had traded strangle positions through Refco.
Both Hans Schneider and Sommerfeld testified that Gaiber recommended that they open accounts with Refco. Both also testified that they obtained Refco's account-opening forms from Johnson. Sommerfeld testified that Gaiber told him that filling out the forms was a routine matter. Hans Schneider testified that Johnson told him that the account-opening forms were a formality. Sommerfeld claimed that he completed the forms in a matter of five minutes. Both Hans and Lisa Schneider testified that they filled in the required information and signed at the required places without reading the documents.
According to both Hans and Lisa Schneider, Gaiber misrepresented the risks and rewards of strangle trading during the Club's Wednesday seminars. Sommerfeld offered similar testimony about Gaiber's representations during a conversation outside the context of the Club's seminars. In addition, Hans Schneider testified that Rhea told him that he could earn more than $30,000 a month trading strangles.
Both the Schneiders and Sommerfeld testified that they relied on Gaiber to select the specific strangle trades executed for their accounts. Sommerfeld testified that he relied on Gaiber to tell him how his account was doing, and that Gaiber told him that he was doing "pretty good" or "okay." The Schneiders testified that they were unable to understand the account statements that Refco sent to them. Both Hans Schneider and Sommerfeld said that they were devastated when they learned about the substantial losses in their accounts.17
Both the Schneiders and Sommerfeld acknowledged that they continued to trade strangles after they learned they were risky and could lead to substantial losses. Lisa Schneider testified that they were desperate and accepted Gaiber's explanation that the market had made an unprecedented move and that continuing to trade was the only way to recover their funds. Sommerfeld initially testified that he closed his account within a week or two of learning about his substantial loss. On cross-examination, however, he admitted that he maintained his Refco account until June 1997 and even agreed to open an account at another FCM so that Gaiber could try to recover his losses.
Gaiber, Rhea, and Johnson offered innocent explanations for all their conduct relating to Club members' strangle trading. They all denied making any deceptive statements about strangle trading or downplaying the importance of Refco's account-opening forms. Each of them also insisted that Refco did not compensate them in any way for making referrals or providing services to Club members.
Johnson portrayed herself as a selfless volunteer eager to help her fellow Club members. She acknowledged that she referred Club members to Refco, but emphasized that Refco offered a low commission rate. She claimed that she attended the majority of the Club's Wednesday seminars and said that Gaiber always explained that risk would be unlimited if a trader failed to liquidate a position on time. She admitted that Club members consulted Gaiber about the specific strangle trades executed for their accounts, but claimed that Gaiber would either agree with the Club member's proposal or advise that it was up to the member. Johnson also acknowledged the role that she had played in calling in Club members' orders to Refco. She testified that she was not really exercising discretion over anyone's trades and explained that she had executed letters claiming that she was exempt from registration because she was advising fewer than 15 clients because Miles told her it was a legal requirement.
Rhea also testified that Gaiber's strangle presentation at the Club's Wednesday seminars was fair and balanced. He said that Gaiber emphasized that risk could be unlimited and urged Club members to watch their positions carefully so they could decide when to get out. Rhea acknowledged that he often referred Club members to Refco, but claimed this was merely because he was a satisfied Refco customer. Rhea acknowledged that he had authored the document indicating that a trader could expect monthly earnings of $5,000 to $10,000 from strangle trading, but denied that he had disseminated the document at the Club. According to Rhea, the document was an example of his habit of writing notes for himself as if he were going to read them and talk back to someone.
Gaiber testified that during his strangle presentation at the Club's Wednesday seminars he emphasized that the result of failing to exit a strangle position at the right time would be getting financially killed. He said that he urged Club members to trade their positions in a manner that limited their risk to one thousand dollars per contract. Gaiber denied that he ever gave opinions about Club members' specific strangle trades and insisted that he told members to rely on themselves. He also denied referring any Club members to Refco. As to the Schneiders, Gaiber testified that he urged them to limit their risk after their large losses in May, but that they did just the opposite.
Miles's testimony portrayed Refco as closely involved with Club members' accounts but generally ignorant of the roles that Gaiber, Rhea, and Johnson played in Club members' strangle trading. Miles said that he believed his experienced staff and competitive commission rate explained the large number of Club members who opened Refco accounts.18 He said that he was unaware that Johnson had built up a supply of Refco's account-opening kits. He emphasized that there were many contacts between Refco and Club members during the account-opening process. He noted that each Club member-client received a copy of Commission-mandated disclosure documents and explained that he expected clients would call him if they had questions about the disclosure documents.
Miles acknowledged that permitting Johnson to communicate orders for Club members who had not granted her discretionary trading authority was not consistent with Refco's usual practice. He also admitted that he knew Johnson had executed a registration exemption letter stating that she advised fewer than 15 clients at the time he learned that Johnson was actually calling in trades for more than 15 Club members. Miles said that he did not think this was a problem because Johnson was not receiving incentive management fees or actually directing the trading in those accounts.
Miles emphasized that his relationship with Gaiber was not friendly and that Gaiber eventually encouraged Refco clients to move to another FCM. As to strangle trading by inexperienced Club members, Miles testified that he did not regard strangle trading as a sophisticated trading method and believed that inexperienced Club members were selecting the strangles they traded on their own.19
Doug Wall ("Wall") testified that he was a Club member who traded strangles through Refco. He said that he was testifying because he believed complainants were trying to evade responsibility for what they had done. He emphasized that he had lost his own money and believed that coming to testify was the "right thing to do."20
Wall said that he attended the Club's Wednesday seminars where Gaiber discussed how different futures markets worked. He explained that Gaiber focused on strangle trading, showed how it worked, and indicated that the risk was unlimited when you sell options. He denied that Gaiber guaranteed that members would making money trading strangles or claimed such trading was riskless. He also said that Gaiber did not encourage him to open an account with Refco.21
Wall indicated that he had received Refco's account-opening kit from Johnson who recommended that he read through it before he opened his account. He said that he found the Commission-required disclosure statement easy to understand and felt it was important to read it because he was putting "a lot of [his] own money on the line."
Wall indicated that Club members openly discussed their accounts with other members. He testified that Gaiber would offer an opinion if you asked him. Wall explained that trades were often determined after a discussion among a group of members and that orders were entered on a bunched basis "just for convenience." He said that he had signed a written power of attorney giving another member discretion to trade his account, but noted that the designated member only made the trades that Wall asked him to make.
Wall testified that Refco faxed and mailed him statements that kept him aware of the activity in his account. He said that he suffered a major loss around the second week of April 1997 and that things "kind of went down hill after that." According to Wall, many Club members discussed the erratic nature of the market around this time. He did not specifically recall discussing the market with the Schneiders or Sommerfeld, but claimed that "[y]ou'd have to be deaf, dumb, and blind not to be aware [of the losses]," because that was "the discussion in the Club."
Wall testified that he had a conversation
with Sommerfeld on the night of the dinner arranged by Refco and that
his impression was that Sommerfeld was a saavy investor who was aware
of what was going on in his account.
The ALJ issued his decision in February 1999. Webster v. Refco, Inc. [1998-1999 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,578 (Feb. 1, 1999.) The ALJ focused his analysis on the theories of liability discussed in complainants' posthearing brief. He considered three theories of direct liability - failure to disclose risk, failure to comply with Commission Rules 1.55 and 33.7, and unauthorized trading;22 one theory of derivative (or agency-based) liability - deception perpetrated by Gaiber, Rhea, and Johnson; and one theory of aiding and abetting liability - Refco's aiding and abetting of the Club's failure to register as an IB.
The judge found that complainants failed to prove that Gaiber's strangle trading presentation at the Club's Wednesday seminars was deceptive. He found that Gaiber's presentation covered trading mechanics, the advantages of strangle trading, the risks involved, and what was required to limit risk. I.D. at 47,668. The Judge specifically found that Gaiber told members that profits were limited to the premiums received and that potential losses were unlimited. I.D. at 47,669-70. In addition, he found that Gaiber did not tell Club members that profits were assured or that strangle trading was risk free. I.D. at 47,669.
The ALJ noted that these findings required a credibility determination. In this regard, he found that Wall's testimony about Gaiber's representations was most credible and stated that he viewed contradictory testimony as incredible if it were not otherwise reliably supported.23 The judge also specifically found that the testimony offered by the Schneiders and Sommerfeld was not credible. As to Sommerfeld, the ALJ noted that: (1) he had an obvious interest in the outcome of the proceeding; (2) his testimony was inconsistent; and (3) his memory was not reliable. I.D. at 47,683 n.176.24 As to the Schneiders, the ALJ noted that both had an interest in the outcome of the proceeding. In addition, he indicated that Hans Schneider: (1) gave inconsistent testimony, and (2) either had an unreliable memory or feigned a lack of memory to avoid answering certain questions. The judge indicated that Lisa Schneider: (1) gave patently inconsistent testimony, and (2) filled in gaps in her memory with self-serving testimony. I.D. at 47,686 n. 206.25
The ALJ did not make a specific credibility analysis of the testimony offered by Gaiber, Rhea, Johnson, Miles, Aiello, Van Essen and McGuire. He did note that, on the whole, the testimony of respondents' witnesses was more credible than that of complainants' witnesses. I.D. at 47,669 n. 46. Moreover, the ALJ based many of his findings on testimony offered by respondents' witnesses.26
The judge concluded that complainants failed to establish that the Club or its agents were acting for respondents for purposes of Section 2(a)(1)(A) of the Act. The judge acknowledged that the record showed that the Club's activities had resulted in a benefit to Refco. He ruled that standing alone, this factor had little probative value in a Section 2(a)(1)(A) analysis. I.D. at 47,698. He noted that there was some evidence that Club officers had referred a limited number of members to Refco, but emphasized the lack of reliable evidence that Refco was aware of this practice. I.D. at 47,699-700.27
The ALJ closely reviewed the evidence
regarding the Club's role in obtaining account-opening documents -
including Commission-required disclosure documents -- from Refco,
providing the documents to Club members, and then returning the
completed documents to Refco. The judge found that the Club did serve
as an intermediary between Refco and a number of Club members. I.D. at
47,702. He noted that there was no reliable evidence that respondents
were aware that the Club was stockpiling account-opening forms and
emphasized that Refco contacted clients directly when there was a
problem with their forms.28
In the context of furnishing account forms, the ALJ discussed complainants' reliance on the Commission's decision in Knight v. First Commercial Financial Group, Inc., [1996-1998
Transfer Binder] Comm. Fut. L. Rep. (CCH)
¶ 26,942 (CFTC Jan. 14, 1997).29 The judge noted that unlike the record
in Knight, the record in this consolidated proceeding failed to
show that Refco (1) expected someone at the Club to fulfill its
responsibilities under Commission Rule 1.55, and (2) referred
questions about account statements and margin calls to someone at the
Club. I.D. at 47,701.
As to complainants' theories of direct liability, the ALJ ruled that they failed to show that respondents breached a duty to disclose material facts.30 The ALJ ruled that complainants did establish that respondents Refco and Dearborn violated Commission Rules 1.55 and 33.7,31 but concluded that the record did not show that the violations proximately caused their losses. The ALJ recognized that this type of violation raised a rebuttable presumption that complainants would have relied on the information disclosed in the Commission-required disclosure documents, but concluded that complainants' signed acknowledgments showed that they had read and understood the required disclosure statements prior to suffering any losses. Consequently, he found that Refco's and Dearborn's wrongdoing did not cause any damages to complainants. I.D. at 47,707-08.
The ALJ found that complainants'
aiding and abetting theory of liability failed because the record did
not establish that the Club was obliged to register. In this regard,
he emphasized that the record did not show that the Club received
either per trade or per referral compensation from Refco.32 He rejected complainants' argument
that the Club's status should be assessed in terms of the
Act's description of an IB's conduct rather than the
definition the Commission adopted in Rule 1.3(mm).33 The judge found that the indirect
compensation that complainants addressed -- an anticipated boost in
the Club's reputation arising from the success of members trading
strangles through Refco - was "too attenuated to bring the Club
under Rule 1.3(mm)'s definition of IB." I.D. at 47,704.
The ALJ also made findings related to the role that respondents' alleged wrongdoing played in complainants' losses. For example, he found that Sommerfeld continued to trade after he was aware of the 26 percent decline in the value of his account between April 22 and April 29, 1997, I.D. at 47,685, and that the Schneiders' continued to trade after they learned that their account had declined by more than $67,000 on April 29, 1997. I.D. at 47,689.34 The judge limited himself to a general conclusion about the significance of these circumstances:
[T]here is evidence that, even if they were lied to, each [complainant] would have stumbled upon information revealing the false nature of those misrepresentations from one of a number of sources and at a point before they claimed to have done so. If this was the case then claims of continued reliance and even initial reliance would have become suspect.
I.D. at 47,716.35
Based on the foregoing analysis, the ALJ dismissed all the complaints due to a failure of proof.
Complainants filed a timely notice of appeal in February 1999 and submitted their appeal brief in April 1999. As to respondents' direct liability, complainants argued that the judge erred by failing to hold that Refco had an obligation under the Act "to make necessary inquiries to determine whether [its] customers understand what they are getting into so that meaningful disclosure can be made." (Complainants' Appeal Brief at 17.) As to respondents' aiding and abetting liability, complainants argued that the ALJ erred in concluding that proof of compensation was a necessary element in a showing that the Club was obliged to register as an IB. They also claimed that the ALJ erred by adopting an unduly limited interpretation of Rule 1.3(mm)'s reference to indirect compensation.
Complainants also challenged the
ALJ's analysis of reliance and proximate cause. They argued that
the ALJ erred by basing his assessment of the harm flowing from
Refco's and Dearborn's violations of Commission Rules 1.55 and
33.7 solely on complainants' execution of acknowledgments.
Complainants contended that the judge should have given greater weight
to the fact that the documents were furnished by unregistered
individuals. Complainants also criticized the ALJ's overall
analysis of complainants' reliance, emphasizing that prior to
opening their Refco accounts complainants had no history of risk
taking or gambling.36
Respondents' answering brief emphasized the ALJ's negative assessment of complainants' credibility and favorable findings regarding respondents' knowledge and conduct. As to direct liability, respondents urged affirmance of the ALJ's conclusion that it was sufficient to disclose the information contained in the Commission-required disclosure documents.37 As for aiding and abetting liability, respondents emphasized that the Commission had clearly indicated that persons who refer clients to an FCM "on an occasional basis and without compensation" were not required to register as IBs. (Respondents' Reply Brief at 9-10.) 38
Respondents also supported the ALJ's
findings on reliance and proximate cause. They endorsed the ALJ's
conclusion that the record rebutted any presumption of reliance
arising from their alleged violation of Commission Rules 1.55 and
33.7.39 They also noted that the
record showed that complainants continued to trade when they were
admittedly aware of the risks of strangle trading. (Respondents'
Reply Brief at 26.)40
We recently observed that as the party with the burden of proof, a complainant who fails to offer reliable testimony generally faces an insurmountable barrier to recovery. Nobrega v. Futures Trading Group, CFTC Docket No. 98-R161 (CFTC September 29, 2000) at 20. This case illustrates the point. A review of complainants' testimony reveals a fundamental inability to recall the specific events at issue in this case. Either intentionally or as a consequence of time passing, each complainant's original recollection has been eroded to a limited group of conclusory statements. The record also shows unexplained discrepancies between complainants' testimony and statements made in their complaints or discovery responses. While the ALJ's explanation for his negative assessment of complainants' credibility reflects a somewhat inflexible and overly perfectionist expectation, the record confirms his core judgment on this issue.
Similarly, the record supports the ALJ's positive assessment of Wall's credibility. Wall had no apparent interest in the outcome and was less inclined to the type of generalization and exaggeration that was common in the testimony of other witnesses. Wall's testimony about Gaiber's strangle presentations at the Club's Wednesday seminars established that Gaiber did explain that strangle trading, which necessarily involved option sales, exposed the trader to unlimited risk. Wall's testimony also indicated that Gaiber played a lesser role in selecting the specific strangle positions that Club members traded than complainants have claimed. Wall also confirmed that Club members frequently discussed trades together and became aware of losses in the accounts of other members. Finally, Wall presented a benign picture of the role that Johnson played in helping him complete Refco's account-opening forms.
Wall's testimony, however, does not address many of the questions raised by the circumstances disclosed on this record. For example, why did Refco offer the same low commission rate to all Club members who opened accounts? If Club members were too unsophisticated to call their own trades into Refco, how could Miles believe that they were sophisticated enough to select the strangle positions executed for their accounts on their own? Given Johnson's attendance at almost all the Club's Wednesday seminars, daily conversations with Refco personnel, and conversations with Miles about the legal requirements for powers of attorney and registration exemption letters, is it likely that she never passed on information about Gaiber's strangle presentations or role in advising members about potential strangle positions? If Refco believed that its duty to disclose risk was fully satisfied by the Commission-required disclosure documents, why did Miles send Aiello and Van Essen all the way to California to disclose the substantial risks of strangle trading? When Refco learned that NFA was investigating charges about Gaiber's activities at the Club, why did it fail to pass the information to its customers who had granted Gaiber discretionary authority over their accounts?
The ALJ resolved some of these questions by crediting the testimony of respondents' witnesses, but he never subjected their testimony to the close scrutiny evident in his review of complainants' testimony. He apparently regarded such scrutiny as unnecessary because respondents' witnesses, on the whole, were more credible than complainants' witnesses. I.D. at 47,669 n.46.
Credibility, however, cannot be assessed on a group basis. Moreover, the fact that respondents' witnesses were more credible than complainants' witnesses does not establish that the testimony of any of respondents' witnesses was sufficiently reliable to support findings based on the weight of the evidence. See Secrest v. Madda Trading Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,627 (CFTC Sept. 14, 1989). Indeed, a review of the testimony of most of respondents' witnesses discloses the same types of flaws that are evident in the testimony of complainants' witnesses. 41
Given these circumstances, the ALJ
committed clear error in generally crediting the testimony of any
witness other than Wall. Of course, if the testimony of most of
respondents' witnesses is disregarded, many of the suspicious
circumstances disclosed by the record remain unexplained. To meet
their burden of proof, however, complainants must do more than point
to suspicious circumstances. They must show that their explanation for
the suspicious circumstances is more likely than any other explanation
for those circumstances. Cf. In re Buckwalter, [1990-1992
Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,995 at 37,684-85
(CFTC Jan. 25, 1991). As to the facts material in this proceeding,
complainants' proof falls significantly short.
The record does not support complainants' claim that respondents failed to fulfill their duty to disclose material facts. The linchpin of complainants' argument - that an FCM must "make necessary inquiries to determine whether [its] customers understand what they are getting into so that meaningful disclosure can be made" - is unsupported by Commission precedent. See Batra v. E.F. Hutton & Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,937 at 34,287 (CFTC Sept. 30, 1987) (rejecting the ALJ's conclusion that the effectiveness of respondent's disclosure should be evaluated in terms of its customer's subjective understanding).42 Moreover, complainants have failed to specify either the circumstances that warranted disclosure beyond the information included in the Commission-required disclosure documents or the information that respondents should have disclosed.
Complainants' arguments relating to aiding and abetting are also flawed. Complainants' emphasis on the plain meaning of Section 4d's language does not undermine our previous determination that Congress authorized us to exempt appropriate persons from the Act's IB registration requirement. As for the type of compensation necessary under Rule 1.3(mm), the preamble explained that the Commission intended to exempt those who referred clients on "an occasional basis and without compensation."43 The record does not establish that the Club received any compensation from Refco. As respondents point out, the compensation that the Club did receive - initiation fees and monthly dues - was a product of the services available at the Club. Complainants argue that an expectation that the Club would eventually profit from its relationship with Refco is sufficient. Such an expectation, however, is not an adequate substitute for actual compensation or profit. Indeed, given the losses suffered by Club members, there is no basis for inferring that the Club actually gained any members due to its connection with Refco.
Finally, we find no merit in complainants' challenge to the ALJ's reliance on their signed acknowledgments as evidence rebutting the presumption of reliance arising from proof that Refco and Dearborn failed to comply with Commission Rules 1.55 and 33.7. The acknowledgments are valid on their face and indicate that complainants read and understood the required disclosure documents. Complainants were free to undermine the weight accorded the acknowledgments by testifying about the actual circumstances of the disclosure. Because their testimony about these circumstances is not credible, however, there is no basis for disregarding the acknowledgments. Consequently, the presumption of reliance is rebutted in the circumstances of this case.44
For the reasons stated herein, we affirm the result of the ALJ's decision and dismiss the complaints for a failure of proof.
IT IS SO ORDERED.45
By the Commission (Chairman RAINER and Commissioners HOLUM, SPEARS, NEWSOME and ERICKSON).
Jean A. Webb
Secretary of the Commission
Commodity Futures Trading Commission
Dated: September 29, 2000
1 During the time at issue, Refco was registered as a futures commission merchant ("FCM"). Dearborn was registered as an introducing broker ("IB"). Refco guaranteed Dearborn's obligations under the Commodity Exchange Act ("Act") and shared employees and a suite of offices with the IB. The record does not explain Refco's rationale for diverting business to Dearborn that it could have done directly.
2 During this period, Refco's commission rates ranged from $19 to $35 per trade.
3 A strangle is defined as an "option position consisting of the purchase or sale of put and call options having the same expiration but different strike prices." (CFTC Glossary: A Layman's Guide to the Language of the Futures Industry (1997).) A trader establishes a strangle position by simultaneously selling a put option having a low exercise price and a call option having a higher exercise price, both having the same maturity. (See M. Desmond Fitzgerald, Financial Options 64 (1987).) Traders sell strangles in order to take advantage of the declining time value of options in markets where they expect stable prices and decreasing volatility. Profit is limited to the premium received. Risk, however, is unlimited because prices may quickly make sharp moves up or down. (See generally Franklin R. Edwards, Cindy W. Ma, Futures & Options 586, 595 (1992).) The likelihood of profit is also affected by the substantial commissions that are often generated by such trading. To avoid significant losses, traders must monitor their positions closely and be prepared to take immediate steps to protect or liquidate deteriorating positions.
4 During the time at issue, Miles was registered as an associated person ("AP") and was sponsored by both Dearborn and Refco.
5 Dearborn's and Refco's shared offices were located in Chicago, Illinois.
6 Aiello and Van Essen were registered as APs sponsored by Refco and Dearborn. Aiello's duties involved the process of opening new accounts and communicating margin calls. Van Essen was responsible for the development of trading systems, but he had some involvement in the communication of margin calls.
7 Gaiber was involved in organizing the Club and the entity that eventually became the Club's parent company - the Bulls and Bears Club Inc. ("BBC Inc."). Both Gaiber's fiancée and daughter contributed substantial amounts to the Club's initial financing. They also controlled the largest blocks of BBC Inc. shares. Both Gaiber and his fiancée were directors of BBC Inc.
In May 1999, The Commission settled an enforcement action against Gaiber. The underlying complaint alleged that between June and December 1997, Gaiber acted as an unregistered commodity trading advisor ("CTA") for a commodity pool. The Commission's order found that Gaiber violated Section 4m(1) of the Act and Sections 4.31, 4.34 and 4.35 of the Commission's regulations. The order imposed a cease and desist order and a three-year trading prohibition as sanctions. Gaiber also agreed not to apply for registration. See In re Gaiber, [1998-1999 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,685 (CFTC June 23, 1999). Most of the events at issue in this appeal took place prior to the period covered by the enforcement action.
8 The document estimated that the chance of failure for strangle trading could be limited to 2 to 3 percent.
9 The record does not disclose how Refco allocated the positions among Club members in the group when a bunched order was either only partially executed or executed at varying prices.
10 He opened a joint account with his wife Pat in April 1997.
11 The Schneiders continued trading strangle positions after May 1997. Some of their trades were in their Refco account and others were in accounts opened at other FCMs. The Schneiders' claim is limited to losses suffered in their Refco account prior to May 6, 1997.
12 Refco's letter supplied the following
information about the Club:
It is my understanding that members pay a flat rate to join the club. Club members are primarily older wealthy individuals. [The Club] receives no commissions or fees from accounts established by its members other than the above. A number of members have established accounts at Refco. There are individual as well as partnership accounts. An account may be traded by the account owner or discretion may be given to another club member.
13 Gaiber was granted discretionary authority over the accounts of nine Club members in written powers of attorney. One of these accounts was the Schneiders'. Complainants did not formally grant Gaiber discretionary authority until after they suffered the losses at issue in this appeal.
14 Complainants are represented by the same counsel. Complainants' counsel also represented several other clients who filed reparations complaints against respondents. Of the eight complaints that counsel filed, four were dismissed during this consolidated proceeding, three were dismissed in an I.D. issued by another ALJ, Playan v. Refco, Inc. [1998-1999 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,617 (Initial Decision Apr. 30, 1999) ("Playan"), and the eighth was dismissed in light of the parties' settlement agreement. We are issuing a separate decision today resolving the appeal from the Playan I.D. filed by complainant Joseph Dennis. Dennis v. Refco, Inc., CFTC Docket No. 98-R007 (September 29, 2000).
15 In this regard, note the change of procedure that we recently instituted to address this problem. McDaniel v. Amerivest Brokerage Services, CFTC Docket Nos. 97-R057 and 97-R058 (CFTC Sept. 26, 2000) at 15 n.21.
16 Due to Sommerfeld's recent illness, all parties agreed to this unusual location for a hearing.
17 The Schneiders indicated that they became aware of the risks of strangle trading after learning of their May 5, 1997 loss. Sommerfeld indicated that he became aware of the risks of selling options on April 29, 1997.
18 Miles denied that he had negotiated a low group commission rate for Club members. He said all Club members were charged a $19 rate because it would be difficult to charge different rates to different members of the Club.
19 Aiello and Van Essen offered testimony that was generally consistent with Miles's testimony. Both indicated that prior to the time the Schneiders suffered a large loss, they had discussed the risks of strangle trading while passing on information about margin calls in complainants' accounts.
20 Wall acknowledged that his loss was limited to $15,000.
21 Club member Mickey McGuire offered somewhat similar testimony about Gaiber's presentation to him. During cross-examination, McGuire acknowledged that he was a friend of Gaiber and had not heard Gaiber's presentation about strangles at the Club's Wednesday seminars.
22 The judge noted that the unauthorized trading claim was limited to complainant Webster. That claim is not at issue in these appeals.
23 In this regard, the judge emphasized that Wall was one of the few witnesses that did not have an interest in the outcome "aligned with the parties that the witness' testimony tended (or was intended) to support." I.D. at 47,669 n. 46. Apparently because Wall had lost money and might want to sue respondents, the judge found that he had testified against his own pecuniary interests. The ALJ also noted that Wall's testimony was frank about the extent of his knowledge as well as consistent. Finally, the ALJ indicated that Wall's demeanor on the stand reinforced his credibility.
24 In this regard, the ALJ emphasized Sommerfeld's difficulty recalling whether he had attended the March 1997 dinner and breakfast arranged by Refco. I.D. at 47,683 n.176. He also noted inconsistencies between Sommerfeld's complaint and testimony concerning the time and location of Gaiber's allegedly fraudulent description of the risks and rewards of strangle trading, the date that he became aware of the precipitous decline in the value of his account, and how Gaiber directed the trading in Club members' accounts. Id.
25 In this regard, the ALJ suggested that Hans Schneider had feigned a lapse of memory rather than admit that Johnson had returned to her trading after giving him Refco's account-opening form and that Gaiber had suggested that he transfer his funds from his Refco account to an account at another FCM. I.D. at 47,686 n. 206. He also indicated that Hans Schneider had contradicted his complaint when he testified that Johnson (rather than Gaiber) had told him that filling out Refco's account-opening forms was a "formality." Id. The judge found that Hans Schneider "provided plainly false testimony" when he said that he really did not understand that the Refco account-opening agreement would govern his relationship with the FCM.
The judge noted that Lisa Schneider testified unequivocally that no one from Refco had contacted her prior to May 5, 1997, but then retreated to insisting that she did not recall when questioned about a discussion with a Refco employee regarding a problem with a wire transfer of funds to Refco. Id. The ALJ also criticized Lisa Schneider for offering contradictory testimony about why she signed Refco's account-opening documents without reading them and who first interested her in commodities trading. Id.
26 The judge's findings about Gaiber's disclosure of the risks of strangle trading at the Club's Wednesday seminars were largely based on Gaiber's, Rhea's, Johnson's, and McGuire's testimony. I.D. at 47,668-70. Based on Johnson's testimony, the judge found that during the period at issue, the Club did not have an official position on a preferred FCM. I.D. at 47,670. He found that respondents did not request referrals, pay for referrals, or have knowledge of Gaiber's referrals to Refco based on Miles's, Johnson's and Rhea's testimony. I.D. at 47, 671. The judge found that Refco was not aware that Johnson was maintaining an inventory of its account-opening forms at the Club and did not direct or authorize Johnson to distribute its account-opening forms or answer Club members' questions about the account-opening forms based on Johnson's and Miles's testimony. I.D. at 47,672-73. He found that strangle trading at the Club was the result of group consensus with limited consultation with Gaiber based on Johnson's, McGuire's, and Wall's testimony. I.D. at 47,673-75. He found that Aiello and Van Essen disclosed the risks of trading strangles at a March breakfast with Club members based on Johnson's, Van Essen's, and Aiello's testimony. I. D. at 47,675-76.
27 The ALJ reasoned that Refco's knowledge of referrals by Club officers could not reasonably be inferred from the fact that respondents were aware that 45 Club members maintained Refco accounts. In this regard, he emphasized that there was no reliable evidence that respondents knew that the members who owned these 45 accounts represented a large percentage of the Club's total membership. I.D. at 47,700.
28 He also noted respondents' testimony that they did not rely on anyone at the Club to oversee the execution of Refco's forms. Id.
29 In Knight, complainant sought to hold an FCM liable for the deceptive statements made by an unregistered individual (Falk) who exercised discretion over complainant's futures account under a written power of attorney. The record showed that (1) Falk referred Knight to the respondent FCM; (2) respondents sent account-opening documents for Knight to Falk; and (3) Knight's account executive (Ambre) acknowledged that he expected Falk to fulfill any responsibilities relating to the completion of the account-opening forms. The Commission ruled that Falk was acting for respondents when he presented the Commission-required disclosure statement to Knight and advised him that completing the documents was a formality. In reaching this conclusion, the Commission noted that respondents had a duty to furnish the Commission-required disclosure document to Knight, obtain Knight's signature on a dated acknowledgment, and retain the acknowledgment in accordance with Commission Rule 1.31. The Commission also indicated that the record showed that respondents did not have any direct contact with Knight prior to opening his account and observed that in this context, respondents either expected Falk to fulfill their obligations or "directly failed to fulfill its obligations under Commission Rule 1.55." Id. at 44,554.
30 He interpreted the argument raised in complainants' post-hearing brief as advocating a per se test inconsistent with the Commission's view that "if [a] broker is acting as a mere agent for execution of customer's orders, compliance with Rule 1.55 will normally fulfill the broker's duty to provide adequate risk disclosure." I.D. at 47,709 citing Holmes v. Wheat First Securities, Inc. [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,823 at 36,875 (CFTC Apr. 3, 1990). The judge also noted that complainants failed to prove that there were any "extraordinary circumstances" affecting their relationship with respondents. I.D. at 47,709-10.
31 Consistent with the Commission's analysis in Knight, the ALJ found that Sommerfeld's and the Schneiders' receipt of Commission-required risk disclosure documents did not establish that Refco and Dearborn had fulfilled their duty to furnish those documents to complainants. Here, the record established that the documents had been furnished by members of the Club who were not acting on behalf of Refco and Dearborn. The judge also found that the Club members who requested the forms from Refco were not agents of Sommerfeld or the Schneiders at the time they requested the account-opening forms. In these circumstances, he concluded that Refco's and Dearborn's failure to directly furnish the required documents to complainants amounted to a "technical" violation of Commission Rules 1.55 and 33.7.
32 The ALJ interpreted language that the Commission included in the preamble explaining its adoption of Rule 1.3(mm) as indicating that persons who were not compensated on a per trade basis or by a referral fee need not register. I.D. at 47,704 quoting Final Rules on Registration and Other Regulatory Requirements, 48 Fed. Reg. 35,248, 35,250-51 (CFTC Aug. 3, 1983).
33 The ALJ noted that legislative history supported the Commission's conclusion that it had the authority to exempt appropriate persons from the Act's IB registration requirement. I.D. at 47,703.
34 As to Sommerfeld, the ALJ also noted that he was present: (1) at the breakfast meeting that Aiello and Van Essen attended, and (2) at the Club in mid April when Club members discussed the substantial trading losses that some members had suffered.
35 As to the aiding and abetting claim, the ALJ ruled that complainants had failed to submit reliable evidence that, but for the Club's failure to register, they would not have suffered damages.
36 Complainants' brief included a motion to reopen the record under Commission Rule 12.405 to permit the submission of new evidence. The new evidence consists of an affidavit signed by complainants' counsel that addresses some of the circumstances relevant to his representation of all the complainants who filed claims against Refco. Because the motion does not establish that the new evidence is material to the outcome of this proceeding, it fails to meet Rule 12.405's requirements. Consequently, we deny the motion.
37 In this regard, they emphasized that the Commission has recognized that the scope of a registrant's duty to disclose varies with the nature of the registrant's relationship with the customer at issue. They argued that the scope of the duty in the circumstances of this case was narrow because complainants did not rely on respondents to either advise them about strangle trading or exercise discretion over the trading in their Refco accounts. (Respondents' Reply Brief at 17.) Respondents also noted that the record showed that Van Essen had provided oral disclosure of the risks of trading strangles to both Sommerfeld and the Schneiders. (Respondents' Reply Brief at 22.)
38 Respondents also supported the ALJ's conclusion that complainants failed to prove that the Club's failure to register played a substantial role in their losses. In addition, respondents argued that the record did not show either that respondents knew that the Club had a duty to register or that they sought to aid the Club in evading its duty. On the latter point, they noted that the record showed that they had specifically asked NFA for advice about the Club's registration status.
39 Respondents reiterated their prior argument that the relevant regulations do not require an FCM to supply required disclosure documents to customers directly.
40 Respondents also pointed out that account statements provided to the Schneiders showed that the account's value dropped 17% only a week after it was opened and then declined 27% on April 11, 1997. They emphasized that these and similar losses were incompatible with the Schneiders' claim that they were unaware of the risk of significant losses until May 5, 1997. Similarly, respondents noted that Sommerfeld's account suffered substantial drops in value on March 31, April 2, April 11, and April 22, 1997 and that more than $34,000 of Sommerfeld's losses were suffered after the April 29, 1997 date that he identified as the first time he was aware of the risks of strangle trading. Respondents argued that complainants' behavior demonstrated that they had an appetite for risk that was not diminished by their discovery of the risks inherent in strangle trading.
41 For example, respondents' witnesses frequently had vivid and detailed recollections of facts favorable to respondents (such as Gaiber's discussion of the risks of strangle trading or the fact that some Club members opened futures accounts with FCMs other than Refco) but cloudy recollections or no recollections of circumstances from the same time period that might help complainants or undermine their own credibility. For example, Johnson was quite sure that Club members had opened accounts at "LIT" - an FCM other than Refco. (Tr. at 586-87.) On cross-examination, however, Johnson said she was not positive about that and acknowledged that she could not identify any Club member who initially opened an account with LIT. Indeed, she acknowledged that she did not know any Club member who opened an account with any firm other than Refco. (Tr. at 639-40.)
Respondents' witnesses also offered testimony that was contrary to information reflected in their answer or responses to discovery. For example, Miles testified that he did not know that Gaiber, Rhea, or Johnson was not registered (Tr. at 486), even though respondents' answer conceded that during the period at issue they had knowledge that these individuals were not registered.
Moreover, facets of the testimony offered by respondents' witnesses clearly strained credulity. Gaiber's testimony suggesting that his role in Club members' specific strangle trades was minimal because he consistently told them not to rely on him falls into this category, as does Rhea's explanation for his written statement touting strangle trading. Given Miles's knowledge of the role Johnson was playing in communicating Club members' trades to Refco, his testimony that he believed that inexperienced Club members were implementing a strangle strategy "on their own" is simply unbelievable.
42 The Commission's analysis in Knight is not to the contrary. Knight's analysis does illustrate the significant risks that FCMs must accept when they isolate themselves from customers and turn a blind eye to the conduct of unregistered intermediaries. Nothing in Knight, however, indicates either that personal contact is mandatory or that inquiries about a customer's subjective understanding are mandatory under the Act. Indeed, customers who open accounts through a registered CTA often do not have direct contact with the FCM where they maintain their accounts.
Of course, FCMs may learn facts that trigger a duty to make additional disclosure of material facts in a variety of ways. For example, they may learn about characteristics of their clients in the process of fulfilling a duty to inquire imposed by NFA rules. In evaluating the scope of the duty to disclose, the proper focus is respondent's knowledge rather than the rule or practice that led to the gathering of the underlying information.
43 Unlike the ALJ, we do not interpret the preamble as suggesting that the compensation must be a per-trade commission or a referral fee.
44 Even apart from the acknowledgments, the record shows that the account statements that both Sommerfeld and the Schneiders received disclosed that the results of strangle trading were volatile. Most importantly, both Sommerfeld and the Schneiders continued to trade strangles well after the time that they conceded their losses made them aware of the risks of the strategy. Such conduct suggests an indifference to the information about risk at the core of the Commission-required disclosure documents.
45 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.