UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
___________________________________ : COMMONWEALTH FINANCIAL GROUP,INC. : : CFTC Docket No. CRAA-95-3 v. : : OPINION AND ORDER NATIONAL FUTURES ASSOCIATION : ___________________________________:
Commonwealth Financial Group, Inc. ("Commonwealth") appeals from a 1995 decision of the National Futures Association ("NFA") finding that it was necessary to impose temporary remedial sanctions on Commonwealth to protect customers from its fraudulent solicitation practices. NFA's decision arises from a member responsibility action it instituted against Commonwealth in 1994. That action focused on allegations that from June 1992 to July 1994 Commonwealth aired a series of deceptive radio advertisements and employed sales representatives who made deceptive telephone solicitations.
On appeal, Commonwealth's principal argument is that NFA is authorized to institute a member responsibility action only in the event of an emergency and that it failed to establish the existence of an emergency in this case. Commonwealth also argues that this action is barred by preclusion principles. In addition, Commonwealth challenges the role played by an NFA attorney during this proceeding. Finally, Commonwealth argues that NFA's member responsibility action rule was not properly promulgated.
As discussed herein, we find no merit to Commonwealth's arguments. Accordingly, the NFA decision is affirmed.
Commonwealth is a Florida-based, independent introducing broker that has been registered with the Commission since 1991. On October 4, 1994, NFA issued a Notice of a Member Responsibility Action against the company (the "Notice"), alleging violations centering on Commonwealth's radio advertising and direct sales solicitations.
The Notice alleged that Commonwealth aired a series of deceptive radio commercials from June 1992 through July 1994, including one-minute and two-minute "spot" advertisements and 15- and 30-minute "infomercials." NFA claimed that the advertisements misrepresented the opportunity for profit and downplayed trading risks.
The Notice alleged that the commercials were flawed primarily because they suggested that large, almost certain profits could be earned by exploiting seasonal fluctuations in heating oil and unleaded gas prices. The Notice said claims about the consistent historical profits of seasonal trades were deceptive and misleading on several grounds. First, the advertisements described price movements in futures contracts, while Commonwealth marketed options on those futures contracts; second, the large gains predicted by Commonwealth from trading energy instruments required buying and selling within narrow time frames that did not correlate to the times at which Commonwealth was offering these investments; and last, Commonwealth's promotion of its heating oil recommendations as a "sure thing" bore "no relation at all to the overwhelming losses Commonwealth customers have suffered." (Notice at 3-4.).
Finally, NFA alleged that Commonwealth's radio commercials contained misleading statements regarding the performance of customer accounts. For example, the advertisements contained statements that individuals had "made money," "made some great dollars here," and "made substantial dollars." When NFA asked the company to support these general statements of favorable past performance, Commonwealth provided information from selected customer accounts showing that in each instance the customer had experienced an isolated profitable trade, while suffering overall trading losses at the time the commercial in question aired.
NFA alleged further that Commonwealth's commercials-- frequently couched in a question-and-answer interview format-- failed to disclose adequately that they were paid advertisements, that the people appearing in them were paid, and that the questions, answers, and opinions were prepared in advance.
The Notice also alleged that Commonwealth's sales representatives used false and misleading direct sales solicitations that mirrored the deceptive advertising claims. For instance, a Commonwealth associated person, Christopher Brown, allegedly told prospective customers he was reaping "fantastic returns" and that there "haven't been too many losers, there's been a lot of winners." However, when Brown made these statements, he had never had a customer close an account with a net profit, the Notice alleged. Three other associated persons, Vincent Caputo, Rudolph Jones, and John Lupu, allegedly made similar misleading statements. The Notice was accompanied by transcripts of radio commercials and of taped sales solicitations.
The Notice also charged that Commonwealth and its president, Charles Hoffecker, failed to supervise employees, that Commonwealth engaged in a deliberate course of conduct to defraud and deceive customers, and that Hoffecker was the architect of this fraud. Overall, the Notice alleged, NFA customers "lost a cumulative $30 million in just three years [and] those few who escaped with a profit never approached the kinds of returns suggested in the commercials." (Notice at 5.)
The Notice imposed remedial sanctions that were to become effective 15 days after the date of the Notice and were to remain in effect until the conclusion of a related disciplinary action against Commonwealth, including any appeal or review process arising therefrom. These included, inter alia, a requirement that Commonwealth provide information about actual profits and losses in its sales solicitations and promotional materials. The Notice stated that Commonwealth could request a hearing prior to the effective date of the remedial sanctions and that such a request would stay the sanctions pending a decision on the allegations of the Notice.
NFA granted Commonwealth's motion to stay the effective date of the remedial measures imposed in the Notice from October 19 to October 28, 1994, at which point Commonwealth requested a hearing. One was scheduled for November 10, 1994 and at Commonwealth's request continued to December 8, 1994. Though Commonwealth did not request discovery, NFA on its own initiative sent the company copies of documents that NFA intended to rely on at the hearing or that NFA deemed relevant to the complaint. The remedial measures continued to be stayed.
In the course of the six-day hearing, NFA presented four of its employees as witnesses: Thomas Duffey, a compliance supervisor; Joy Carrick, an auditor; Lori Werth, associate director of compliance; and Irene Bumpus, a compliance supervisor who oversaw the Commonwealth investigation.
Duffey, Carrick, and Werth testified as to how Commonwealth's advertising and sales practices came under NFA scrutiny. These witnesses testified that their responsibilities included monitoring promotional materials and financial data submitted by NFA registrants in the normal course of business. They said that, in reviewing Commonwealth's advertising over a period of time, they were led to question some of the statements made therein, particularly claims regarding trading gains achieved by Commonwealth customers and predictions made concerning seasonal volatility in energy prices. On several occasions they asked Commonwealth to submit documentation supporting advertising claims. Commonwealth's responses to such requests were inadequate to assuage NFA's rising concerns.
NFA witnesses authenticated various items of promotional material they had reviewed along with Commonwealth's responses to NFA's requests for supporting documentation. Carrick, in addition, authenticated material submitted by Commonwealth to support statements made by its associated persons.
Irene Bumpus provided extensive testimony regarding how NFA investigators reached the conclusion that statements made by Commonwealth were false and misleading. Bumpus testified that she reviewed the market research Commonwealth said it used in making recommendations to customers and found that it failed to support the statements purportedly based on it.
Among other examples, she cited a Commonwealth radio advertisement containing a statement that the heating oil contract had been profitable 11 out of the last 13 years. In response to NFA's request for support for the statement, Commonwealth submitted a document entitled "Special Report on Heating Oil." The report contained a chart showing that the December futures contract would have been profitable 11 out of 13 years if it had been purchased around July 28 and liquidated around October 16 of each year. (Tr. at 528, 531-534).
Bumpus identified numerous problems with the advertisement, including the palpable defect that the chart gave statistics for futures rather than the options marketed by Commonwealth. In addition, the chart purportedly covered 13 years of trading history, although the heating oil futures contract did not begin trading until 1987. Moreover, while the trading profits shown on the chart required entering and exiting the market at specific times, the advertisement said nothing about entry and exit points, and trades were actually executed for Commonwealth's customers without regard to market timing. Bumpus acknowledged that the research charts on which Commonwealth based its trading recommendations contained the required disclosures regarding hypothetical trading results, but said a radio listener would have no way of knowing the disclaimers existed. Finally, the advertisement was silent on the point that the vast majority of Commonwealth customers who traded heating oil options lost money. (Tr. at 533, 534-536, 536-538, 540-546, 552-554).
Another advertisement challenged by NFA claimed that unleaded gasoline had been profitable "eight out of eight years," a statement shown to have been repeated by Commonwealth's associated person Rudolph Jones in a telephone solicitation. When NFA asked Commonwealth to defend this statement, Commonwealth submitted a research chart showing that a hypothetical trade would have been profitable if entered into on March 1 and liquidated on April 2 of each year. (Tr. at 555, 569).
Bumpus testified that this advertisement contained many of the same flaws as the heating oil commercial. The research chart referred to unleaded gas futures while Commonwealth solicited customers to trade unleaded gas options; Commonwealth ran advertisements and solicited customers to invest at times other than the market entry points listed in the report; and only six of 99 customers who traded unleaded gasoline options between September 1992 and April 1993 made money. The average profit was $1,800 while the average loss was over $6,000. (Tr. at 557-559, 560-561, 562-564).
Another group of advertisements, which featured Hoffecker as spokesman for Commonwealth, represented that customers were making money in sugar and gold. Similar claims were made in telephone solicitations by Vincent Caputo and Christopher Brown. Bumpus testified that once again these claims did not withstand scrutiny and NFA found customers were losing money trading these commodities when the statements were made. One such commercial aired on April 29, 1993, stating that Commonwealth customers had made money trading sugar options. Two others, broadcast on May 20 and May 27, 1993, said customers had made substantial amounts of money in gold. When asked to support these representations, Commonwealth provided customer statements for 13 accounts. The account statements reflected isolated instances of small profits. However, most customers had lost or were losing money at the time the advertisements ran. (Tr. at 577-579, 580-583, 583-587).
The same advertisements stated that Commonwealth customers were seeing overall profits in their accounts. Nevertheless, Bumpus testified that for the 13 statements Commonwealth submitted to support the advertisements, all the customers were suffering losses at the end of April and May 1993 with cumulative losses of $120,000 in April and $180,000 in May. No customers closed their accounts with a profit. (Tr. at 581, 584, 586-587).
In addition, Bumpus reviewed Commonwealth's year-end profit and loss summaries as of December 1991 and December 1992. Commonwealth customers lost over $4 million dollars in 1991 and $15 million dollars in 1992. Only 154 of the 857 customers who closed accounts in 1991 had equity when they closed them. The average equity in these accounts was $1,163.90. The average loss was $6,093.76. In 1992, 103 accounts were closed with equity. The average equity in these accounts was $1,567.58, while the average loss was $9,023.29. (Tr. at 572-577).
Bumpus testified that none of Commonwealth's radio advertisements met NFA's requirements because they failed to disclose adequately that the persons appearing in them were paid by Commonwealth and that the questions and answers had been prepared in advance. In addition, disclaimers were not made at the beginning and end and, for longer commercials, in the middle of each advertisement.
Commonwealth presented five witnesses. Thomas Parker, a former NFA employee retained by Commonwealth in August 1992 to assist with Commonwealth's compliance program, testified regarding the methods he used to assist Commonwealth to develop its compliance system. Parker said that in his opinion people would not be misled by Commonwealth's sales statements, nor did he think brokers acted in violation of their duties. He admitted that some mistakes were going to be made among Commonwealth's large force of brokers, but thought that the company took proper steps to respond to any transgressions. On cross-examination, Parker admitted that he did not know whether Commonwealth took specific corrective actions based on his compliance reports. (Tr. at 801-804, 810-811, 820-821, 832, 836, 862, 865-869, 872, 876).
Paul Cissell testified that he owns a commodity trading advisory business that provides consulting services consisting of research and trading advice. (Tr. 929-936). Cissell testified that he reviewed a number of assertions in the radio advertisements concerning seasonality and price movements and concluded that none of the statements was incorrect or materially false. (Tr. at 989-991, 994-995). Bud Halberg, owner of Scan Management, Inc., another consultant retained by Commonwealth, said the five advertisements he analyzed were balanced, "notwithstanding an indiscretion here and there." (Tr. at 1076- 1080).
Commonwealth also called Daniel Driscoll, the director of compliance at NFA, as a hostile witness. Driscoll had testified for the Commission in a federal district court injunctive action brought by the Commission against Commonwealth. Driscoll denied that NFA brought the member responsibility action in response to the district judge's decision to dismiss the injunctive action. (Tr. 1170-1177).
Commonwealth's final witness, its president, Charles Hoffecker, stated that the sanctions proposed in the Notice would put Commonwealth out of business. He also testified that Commonwealth took compliance seriously. Moreover, he said he hired Parker and Halberg to improve his compliance program after the Commission filed its injunctive action. Finally, he testified that he has counseled, suspended, and even fired brokers who "crossed the line." (Tr. at 1219-1220, 1223- 1224, 1226-1228).
On February 27, 1995, NFA issued a 50-page decision finding that Commonwealth, under the leadership of Hoffecker, had engaged in a course of conduct intended to defraud and to deceive its customers. NFA found that the evidence proved that Commonwealth's advertisements contained many misleading statements. NFA chose not to rely on the opinion testimony of either side in deciding whether a commercial or solicitation was misleading. Instead, the hearing panel relied on its own evaluation of the radio advertisements and sales solicitations.
NFA found that some of the statements in the commercials were patently inaccurate and concluded that others, even if accurate when viewed in isolation, were misleading when viewed in the light of other relevant facts. NFA found that, because Commonwealth's commercials gave the impression that customers typically made money, it could not omit the material fact that Commonwealth's customers in fact suffered substantial losses.
NFA also found that the advertisements were deceptive because they failed to disclose that option prices do not move in one-to-one increments with futures prices, that the trades were based on hypothetical statistics, and that the hypothetical data bore no relation to the dates on which customers were solicited. In addition, NFA found the advertisements to be misleading because they sounded like investment programs rather than commercials and did not contain the appropriate disclosures. Finally, NFA held that Commonwealth's sales solicitations contained the same deceptive and misleading statements as the advertisements. See generally NFA Decision at 38-48.
NFA imposed remedial measures that required Commonwealth to submit all its promotional material to NFA before use and to refrain from using it until Commonwealth received NFA's approval. Commonwealth also was required to tape record all conversations with current and prospective customers. Finally, Commonwealth was ordered to inform its customers of the existence of the member responsibility action and the nature of NFA's findings and to provide customers with a copy of the decision upon request. NFA directed that the remedial measures stay in effect until the conclusion of the related disciplinary action pending before its Business Conduct Committee. Commonwealth sought review of NFA's decision here and also asked us to stay the remedial measures while its appeal was pending. We granted partial relief from the effect of the remedial measures, staying that portion of NFA's order that required Commonwealth to advise customers of NFA's decision. See Order of March 14, 1995.
Commonwealth challenges NFA's decision on the ground that NFA failed to establish an emergency warranting a member responsibility action and on the ground that the member responsibility action was barred by the doctrines of res judicata and/or collateral estoppel. Commonwealth also raises two lesser arguments, contending that as a general rule the imposition of remedial measures through the vehicle of a member responsibility action constitutes improper rulemaking by NFA and that an NFA staff attorney's role as advisor to the hearing panel in this matter was improper. NFA seeks affirmance of its decision in all respects.
We turn first to Commonwealth's argument that preclusion principles barred this action. Commonwealth contends that, because a U.S. district court judge found insufficient evidence of systemic fraud at Commonwealth to justify granting the Commission's request for a permanent injunction, NFA is thereby barred from litigating these issues in this action. CFTC v. Commonwealth Financial Group, Case No. 92-6692-CIV-RYSKAMP (S.D. Fla. Aug. 31, 1994). The member responsibility action Notice was issued approximately one month after the district court in Florida denied the Commission's request for injunctive relief.
This argument fails for the simple reason that the U.S. Court of Appeals for the Eleventh Circuit vacated and remanded the district court's decision. A decision that has been vacated or overruled has no preclusive effect. See Del Rio Distributing, Inc. v. Adolph Coors Co., 589 F.2d 176 (5th Cir. 1979), cert. denied 100 S. Ct 80 (1979) (a case based on decision that has since been overruled has no preclusive effect for the purposes of collateral estoppel); accord, Associates Capital v. Loftin's Transfer & Storage Co., 554 F.2d 188 (5th Cir. 1977) (where on appeal case was remanded to the district court, decision of district court had no precedential effect and rendered nugatory the question of collateral estoppel).
Even if the district court decision had not been vacated and remanded, Commonwealth's argument that this proceeding should be barred by preclusion principles would still fail. A party relying on either collateral estoppel or res judicata must show that the claims or issues in the case in which preclusion is sought are the same as the claims or issues litigated in the prior proceeding. While the Commission's injunctive case alleged wrongdoing similar in nature to that alleged by NFA, preclusion requires an identity between the facts and issues of two cases that is absent here. The Commission's case is based exclusively on sales solicitations that occurred prior to July 1992. In contrast, this action involves radio commercials that ran between June 1992 and July 1994 and sales solicitations made to customers in the spring of 1993. Given these circumstances, preclusion principles clearly do not apply to this case.
Commonwealth next argues that a member responsibility action may be instituted only if there exists an imminent threat to the public or another emergency situation of equivalent severity. Commonwealth's argument relies principally on its interpretation of our decision in a prior appeal from a member responsibility action decision, Presidential Futures, Inc. v. National Futures Association, Comm. Fut. L. Rep. [1990-1992 Transfer Binder] (CCH) 25,228 (CFTC Jan. 23, 1992). Based on its reading of Presidential, Commonwealth contends that NFA's allegations of misleading advertising and improper sales solicitations do not constitute the type of emergency circumstances that justify bringing a summary member responsibility action.
The text of NFA's rule authorizing it to bring a member responsibility action provides:
A Member or Associate may be summarily suspended from membership, or association with a Member, may be required to restrict its operations . . . or may otherwise be directed to take remedial action, where the President, with the concurrence of the NFA Board of Directors or Executive Committee, has reason to believe that summary action is necessary to protect the commodity futures markets, customers, or other Members or Associates. Notice of such summary action shall be given promptly to the Commission.
NFA Compliance Rule 3-15(a).
The standard articulated in the rule is whether NFA has reason to believe that summary action is necessary to protect the markets or customers. We find that this standard has been met. NFA alleged and proved that Commonwealth engaged in a deliberate course of conduct designed to defraud and to deceive its customers. Commonwealth's fraudulent advertisements and solicitations cut a wide swath, as shown by the magnitude of customer losses in a relatively short period of time. Its misleading radio advertisements held out a virtual promise of large profits at low risk, and its associated persons reinforced this impression.
The extent of the fraud within the company is particularly troubling. The misleading promises of sure success permeated every level of Commonwealth--from president Hoffecker down to the individual associated persons. Hoffecker appeared as Commonwealth's spokesman in many of the radio advertisements and, despite repeated inquiries and warnings from NFA, failed to take effective corrective action.
The fraud was continuing. It persisted over a two-year period with no sign of abatement, despite repeated inquiries from NFA. The record showed that the practices at issue here were maintained until at least the month before the member responsibility action Notice was issued. (Tr. at 615, 617, 696, 906.) Meanwhile, Commonwealth customers suffered losses variously described by NFA as "substantial," NFA Decision at 40, and "overwhelming." Id. at 44.
In these circumstances, given the nature, scope and continuity of the fraud, we conclude that NFA did not err in concluding that it had reason to believe that the member responsibility action was necessary. The weight of the evidence adduced at the hearing supports NFA's findings of widespread customer fraud. In the proper discharge of its oversight responsibilities, NFA could not allow such conduct to go unchecked, and by moving expeditiously, but not so precipitately as to deprive Commonwealth of notice and a hearing, NFA clearly complied with its responsibilities under Rule 3-15.
Furthermore, we find that the remedial measures imposed are appropriate. The tape recording of sales solicitations and the submission of promotional materials before their use are supervisory requirements that will allow NFA to monitor Commonwealth's compliance with NFA's rules. The requirement that Commonwealth inform each prospective customer that the member responsibility action panel found that Commonwealth had "misled and deceived customers through its advertising and sales solicitations" will allow potential customers to make an informed choice about who they select to make investments on their behalf.
Commonwealth's argument that the Commission's decision in Presidential requires that we overturn NFA's action is misplaced. A close analysis of the circumstances at issue in Presidential show that case is distinguishable from the instant matter. In Presidential, NFA issued a member responsibility action notice against Presidential Futures, Inc., a registered introducing broker. The notice generally alleged that Presidential was engaging in widespread and pervasive sales practice abuses in apparent violation of NFA requirements, but provided no details: it neither identified specific NFA rules Presidential had allegedly violated nor described the nature or extent of the alleged threat to commodity futures markets, customers, or NFA members posed by Presidential's conduct. The notice further stated that, effective in three days, Presidential would be barred from soliciting or accepting any customer accounts or funds and from accepting or placing trades for customer accounts (except for trades liquidating existing positions).
Upon review of the record in that case, we determined that NFA had failed to conform its proceeding to the requirements of fundamental fairness. NFA did not develop documentation establishing a reliable basis on which to take summary action against Presidential. The notice was issued without supporting affidavits or other readily obtainable records establishing the reliability of the charges against Presidential. Id. at 38,661. Nothing in the notice specified the purported emergency or the precise nature of the public interest NFA sought to protect through use of a summary proceeding. Indeed, we found that the investigative report, the only document accompanying the notice, "raised more questions then it answer[ed]" regarding the nature of the factual allegations against Presidential. Id. Since the notice omitted any description of specific conduct and identification of the NFA rules purportedly violated, Presidential was prevented from adequately defending itself, particularly since it was given less than 48 hours to prepare for the proffered hearing. We therefore vacated the member responsibility action.
In analyzing the requirements of fundamental fairness, we noted that courts have upheld the imposition of summary action without a hearing in situations where "emergency action" is warranted. Id. at 38,660. Addressing the circumstances of Presidential, we said:
[W]e can infer that NFA seeks to protect customers from fraudulent inducement. An allegation of fraudulent inducement, however, standing alone, is insufficient to justify emergency action.
Id. at 38,662.
It is this language, Commonwealth contends, that requires NFA to prove that there existed an emergency situation to justify its commencement of a member responsibility action to protect customers. However, Presidential is facially inapplicable to this case. Although NFA proceeded against both Commonwealth and Presidential under its Compliance Rule 3-15, no two proceedings could have been more unlike. Here, NFA provided Commonwealth with a specification of the precise rules violated and a specific description of the alleged fraudulent sales practices, including dates, times, content, transcripts, and participants. This level of detail stands in stark contrast to the vague and conclusory allegations in the member responsibility action notice at issue in Presidential. Accordingly, Commonwealth was provided adequate notice of the charges against it, and it does not argue otherwise.
Moreover, Commonwealth was given a meaningful opportunity for a hearing. Here, the Notice was issued on October 4, 1994, with the proposed sanctions to become effective within 15 days, or on October 29. NFA, however, granted Commonwealth's request to stay the sanctions pending a hearing, which was first scheduled for November 10 and then re-scheduled for December 8 at Commonwealth's request. Although Commonwealth sought no discovery from NFA in preparation for the hearing, NFA voluntarily produced relevant documents to Commonwealth. The hearing lasted six days and involved testimony by four witnesses on behalf of NFA and five on behalf of Commonwealth. Unlike the situation in Presidential, Commonwealth had adequate notice of the charges against it and was afforded a full opportunity to litigate those charges. Because Commonwealth was provided fair notice and a full hearing prior to the imposition of any remedial measures, Commonwealth's reliance on Presidential is unavailing.
Accordingly, we hold that NFA acted consistently with the requirements of the Act, NFA rules, and fundamental fairness in bringing the member responsibility action.
* * *
We turn now to Commonwealth's contention that NFA's imposition of remedial measures pursuant to Rule 3-15 constitutes improper rulemaking because the measures imposed are not spelled out in the rule. This argument is frivolous. Rule 3-15 authorizes NFA to fashion remedial measures suitable for a particular case and to deal with unforeseen circumstances as they arise.
Moreover, Commonwealth's attack on the manner of Rule 3-15's promulgation is similarly unpersuasive. Notice and comment rulemaking was not required, as Commonwealth suggests. Rule 3-15 was submitted to and approved by the Commission, as are all NFA rules.
We also find unavailing Commonwealth's challenge to the propriety of a NFA staff attorney's serving as counsel to the hearing panel. Specifically, Commonwealth claims that the staff attorney's participation calls into question the ability of the panel to be neutral and disinterested. NFA responds that the staff attorney played a limited ministerial role in the proceeding by providing legal advice on procedural questions. In this case, Commonwealth has not shown that the attorney served in a prosecutorial role, nor has Commonwealth identified any bias resulting from the attorney's participation. In the absence of any evidence that the panel's legal advisor played a role in the prosecution of this matter and/or had any effect on the panel's decision, this practice does not support a finding of bias that would constitute a violation of fundamental fairness. Cf. Schultz v. Securities and Exchange Commission, 614 F.2d 561, 569 (7th Cir. 1980) (no such violation occurred where a securities exchange prosecutor drafted a notice of decision for the SRO's
business conduct committee, because the decision had been made by judges without any input from the prosecutor).
For the reasons above, we hereby affirm the member responsibility action.
By the Commission (Chairperson BORN and Commissioners DIAL, TULL, HOLUM and SPEARS).
Jean A. Webb
Secretary of the Commission
Commodity Futures Trading Commission
Dated: March 18, 1997