UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
A. ANTOINE KACEM
CFTC Docket No. 95-R030
OPINION and ORDER
CASTLE COMMODITIES CORPORATION
A. Antoine Kacem filed a reparations complaint against respondents Merchants Trading Company ("Merchants"), Quantum Financial Services, Inc. ("Quantum"), Internationale Nederlanden (U.S.) Derivatives Clearing, Inc. ("ING"), Castle Commodities Corporation ("Castle"), and Nasser Bakizada, a registered associated person (AP) and employee of Castle, alleging fraud, unauthorized trading, an illegal guarantee, and failure to supervise./ The ALJ dismissed the complaint against Castle on the grounds that the claim was barred by the two-year statute of limitations in the Commodity Exchange Act ("Act"), Section 14(a)(1), 7 U.S.C. ' 18(a)(1)(A) (1994), and that complainant failed to prove violative conduct resulting in damages./ On appeal, Kacem seeks reversal of the ALJ's dismissal order and damages of $32,536.
Based on our independent assessment of the factual record, we reverse the ALJ and award full damages to complainant in the amount of $32,536. This award is based on our finding that Castle, a guaranteed introducing broker (IB), is vicariously liable for violations of Section 4b(a) of the Act, 7 U.S.C. ' 6b(a) (1994), for Bakizada's unauthorized trading and fraudulent lulling; liable for violations of Commission Rule 1.56, 17 C.F.R. ' 1.56 (1997), for Bakizada's illegal guarantees against loss; and liable for violations of Rule 166.2, 17 C.F.R. ' 166.2 (1997), for Bakizada's unauthorized trading. The basis for our decision is explained more fully below.
Complainant opened a non-discretionary commodities account at Merchants, introduced by Castle in November 1991, initially depositing $7,000./ Complainant testified that he met with Bakizada and Muraji Nakazawa, Castle's Chief Executive Officer, in early 1992 and they said they were "doing very well for their clients." (Tr. at 13.) Complainant testified that he went to Bakizada's home to review his computer trading system and that Bakizada explained the system to him and said it was doing well and was always accurate. (Tr. at 15.) Complainant testified that Bakizada's explanation to him indicated that the system never failed. Id. Complainant testified that, Bakizada told him that he and Nakazawa, a principal of Castle, were partners in Castle. (Tr. at 12.)
Bakizada acted as the AP for complainant's account, which traded through March 1993. The account initially experienced profits, and complainant deposited an additional $5,000 in the account in June 1992. In late July 1992, complainant left the country for a five-week vacation abroad, leaving telephone numbers with Bakizada where he could be reached.
Complainant had no contact with Bakizada while he was out of the country. When complainant returned to the United States in September 1992, he found that Bakizada had executed several trades for his account which resulted in losses of approximately $23,700. Complainant testified that these trades were unauthorized and that he had not given Bakizada discretion to make trades in his absence. (Tr. at 21-23, 27, 28.)
Bakizada wrote a letter to complainant on September 3, 1992, informing complainant of the losses in the account, purporting to explain why they occurred, and including a statement indicating that Bakizada would be willing to guarantee complainant's account. In pertinent part, the letter stated:
I told . . . [another customer] that she shouldn't worry because I will personally guarantee her $10,000. But please, this is off the record, I am doing this as a friend. I will do the same with you if need be. Just don't worry, your money (and . . . [the other customer's]) as [sic] considered more important than my own. I have the confidence that I will succeed in making money for all of us.
After receiving this letter, complainant said that he was "devastated." (Tr. at 30.) Shortly thereafter he contacted Bakizada and "asked him what happened" in his account. Id. Complainant stated that Bakizada told him that his investment was safe and asked him for additional funds in order to continue trading and to recoup the previous trading losses. (Tr. at 30-33; Complaint && 19, 20.) Complainant testified that he did not accept the August 1992 trades as his own. (Tr. at 76-77.) Nevertheless, Kacem thereafter deposited additional monies into the account from October 1992 to February 1993. Complainant deposited $10,000 in the account in October 1992, $9,000 in December 1992, and $7,000 in February 1993. The February deposit included a $5,000 payment from Bakizada, which complainant testified was made pursuant to the guarantee. (Tr. at 78.) At some point in late 1992, complainant apparently orally gave Bakizada discretion to trade his account, Complaint, & 23; there is no evidence that any written authorization was ever executed by complainant at any time. (Tr. at 22.)
Bakizada continued to trade the account through March 1993, despite heavy trading losses. Complainant testified that Bakizada continued to provide him during this period with assurances that the funds would be recouped through trading or, in the alternative, that Bakizada would reimburse complainant. (Tr. at 32-35.) At the end of March 1993, complainant instructed Bakizada to cease trading in his account; at that point the equity in the account was $1,738.
Complainant stated that he spoke with Nakazawa, Castle's Chief Executive Officer and Bakizada's supervisor, in May 1993 and "explained to him the situation of my account." (Tr. at 38.) He also testified that Nakazawa would not meet with him in person and refused to return his telephone calls. (Tr. at 38, 39.) Nakazawa claimed that he received nothing more than an inquiry from complainant about his account, with no mention of unauthorized trading, and added that he had no reason to believe anything was amiss in the account because all trading slips were signed and stamped according to procedures. (Tr. at 93.) No action was taken by Castle in response to complainant's objections. Nakazawa stated that complainant maintained a self-directed account until it was closed and never informed Castle of any unauthorized trades. (Tr. at 98.) Nakazawa claimed to lack knowledge of the $5,000 payment made by Bakizada to complainant. (Tr. at 96.)
John Carmichael, an AP at Castle, testified at the hearing that he sat near Bakizada's desk, that he overheard numerous conversations between Bakizada and complainant, and that he never heard Bakizada ask for authorization for any trade. (Tr. at 86, 89.) Carmichael stated, "I overheard every conversation of Mr. Bakizada with his clients, including Mr. Kacem, and I can state unequivocally as God is my witness, there was not a single occasion which Mr. Bakizada ever asked Mr. Kacem for his approval for any trade." (Tr. at 86-87.) Carmichael further testified, "I frankly assumed that Mr. Bakizada had discretion in that account." (Tr. at 88.)
The ALJ dismissed the complaint, finding that, overall, Kacem's testimony was not credible. Initial Decision at 3-4. Moreover, the judge stated that Kacem had "secretly worked out a deal with Bakizada whereby he could not lose." Initial Decision at 5. The ALJ concluded that Bakizada exercised discretion over the trading in the account "with the full knowledge of Kacem." Initial Decision at 2. In support of this conclusion, the ALJ pointed to Carmichael's testimony that at no time did he overhear Bakizada asking Kacem for trading instructions. Id. The judge also emphasized that Kacem made no attempt to check on the status of his account while he was away and inferred from this "that Kacem had an arrangement whereby Bakizada was to make all trading decisions in the account in his absence." Id. at 3. Finally, the ALJ found that there was no credible evidence that Bakizada guaranteed Kacem's account against loss. In light of these findings, the ALJ concluded that Kacem's unauthorized trading claim was barred by the statute of limitations and that no violations of law had been proven.
On appeal, Kacem argues that Bakizada's guarantee against losses "lulled" him from pursuing his claim in a timely manner. Appeal Brief at 12-14. He also argues that Castle waived a statute of limitations defense by failing to raise it in its answer. Appeal Brief at 10-11. Kacem also challenges the ALJ's findings that Bakizada exercised discretion over Kacem's account "from the outset" with Kacem's full knowledge. Kacem argues that, since nothing supports a finding that he ratified Bakizada's unauthorized trades, he is entitled to damages of $32,536.
The ALJ's Credibility Findings
The ALJ based his findings, not on the testimony and documents in the case, but rather on negative inferences based on his determination that the complainant lacked credibility. The ALJ decided, without any evidentiary support, that "Kacem continued to trade because he believed he had secretly worked out a deal with Bakizada whereby he could not lose." Initial Decision at 5. The ALJ's opinion was that Bakizada and complainant were in collusion and that, because of this, Castle was unable to detect any wrongdoing on the part of its employee. The ALJ's credibility findings, however, appear to be based solely on a misreading of the September 3, 1992 Bakizada letter. The ALJ apparently read the language, "[p]lease don't share this confidential information with . . . anyone else," as relating to the guarantee when, as is apparent from reading the language in context, that particular clause refers to Bakizada's disclosure that he will be leaving Castle./ Furthermore, the ALJ apparently inferred from this misreading that complainant and Bakizada conspired to keep Castle uninformed. The record fails to support this conclusion.
The ALJ also speculated that Bakizada exercised discretion over the trading in the account with complainant's full knowledge. The ALJ emphasized that complainant did not check on his account while he was out of the country, which he ruled "strongly suggests that Kacem had an arrangement whereby Bakizada was to make all trading decisions on the account in his absence." Initial Decision at 3. A much more likely reason, however, was that complainant had not at that point authorized any discretionary trading in the account and assumed that there would be no trading in the account while he was gone unless Bakizada contacted him.
The ALJ also implied that complainant's settlement with Bakizada was a suspicious circumstance. The fact of such settlement with one party has no evidentiary significance in the ongoing proceeding against another. The ALJ also criticized complainant for failing to disclose promptly the alleged guarantee to Castle. Castle, however, as Bakizada's employer, had the responsibility to know and to control the behavior of its brokers vis-a-vis its customers such as complainant. See 17 C.F.R. ' 166.3 (1997). Complainant had no such duty to report Bakizada's behavior to Castle.
In sum, there is insufficient basis in the record to support the ALJ's credibility findings. More significantly, the decision below does not address the respondent's failure to obtain written authorization for the trading in violation of Rule 166.2 or the alleged violations of Rule 1.56 and Section 4b of the Act.
Violation of Rule 166.2
Commission Rule 166.2 requires that no FCM, IB, or any of their APs may effect commodity transactions for a customer "unless before the transaction the customer, or person designated by the customer to control the account . . . [s]pecifically authorized the [FCM, IB, or AP] to effect the transaction . . . or . . . [a]uthorized in writing [the FCM, IB or AP] to effect transactions . . . for the account without the customer's specific authorization." Rule 166.2 states that a transaction is specifically authorized if:
the customer or person designated by the customer to control the account specifies (1) the precise commodity interest to be purchased or sold and (2) the exact amount of the commodity interest to be purchased or sold . . . .
We find that there was a violation of Rule 166.2 in this case in that, while complainant was out of the country, Bakizada traded complainant's account in a discretionary manner without having written authorization to do so. It is undisputed that no written authorization was obtained to trade complainant's account. Complainant alleged this fact in the complaint/ and testified to this effect. (Tr. at 21, 22.) Complainant responded negatively to questions relating to the existence of a discretionary account form. (Tr. at 22.) In addition, there is no evidence to support a finding that specific authorization was obtained. Complainant indicated that he expected Bakizada to call him prior to each transaction. Complainant further testified that he told Bakizada not to trade his account while he was out of the country and that he had to get prior authorization for any trades. (Tr. at 23.)
The fact that no specific trading authorization was obtained from complainant is supported also by testimony from John Carmichael, an AP at Castle and Castle's own witness at the hearing. Carmichael testified that he sat near Bakizada's desk, that he overheard numerous conversations between Bakizada and complainant, and that he never heard Bakizada ask for authorization for any trade. (Tr. at 86, 89.) Carmichael testified, "there was not a single trade in which he called up and asked Mr. Kacem's approval based on remarks I heard Mr. Bakizada say in that office during the year 1992" (Tr. at 89), and "I overheard every conversation of Mr. Bakizada with his clients, including Mr. Kacem, and I can state unequivocally as God is my witness, there was not a single occasion which Mr. Bakizada ever asked Mr. Kacem for his approval for any trade." (Tr. at 86, 87.) Carmichael further testified, "I frankly assumed that Mr. Bakizada had discretion in that account." (Tr. at 88.)
Additional support for a violation of Rule 166.2 is found in the lack of documentary evidence of a trading authorization. Rule 1.37, 17 C.F.R. ' 1.37 (1997), requires that an IB keep records of the names of persons who exercise trading control with respect to commodity accounts that it introduces. Therefore, if there had been a written authorization executed by complainant for Bakizada to trade, Castle would have been required to retain the document in its records. Such document, if it existed, would have been in Castle's possession and control. Inasmuch as it would have been in Castle's interest to produce the authorization and Castle failed to do so, the inference may be drawn that such a document did not exist.
The oral permission to trade given by complainant to Bakizada in late 1992 does not affect the liability analysis under Rule 166.2. In In the Matter of Heitschmidt, et al., [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) & 26,263 at 42,204 (CFTC Nov. 9, 1994), the Commission stated:
A liability analysis under Commission Rule 166.2 focuses on two issues: (1) whether there was a written power of attorney in effect at the time of the transaction at issue and, if not, (2) whether the transaction was specifically authorized by the customer in advance of its execution. See Wolken v. Refco, Inc., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) & 24,509 at 36,188 (CFTC July 18, 1989). Under Rule 166.2, a customer's oral grant of general discretion to an account executive is irrelevant to the analysis of liability, because the rule renders such oral agreements void. Id. The customer's post-transaction conduct is equally irrelevant to an analysis of liability, because a transaction cannot be specifically authorized unless the customer selects the type of transaction (purchase or sale), the commodity interest, and the exact amount of the commodity interest, in advance of the transaction. (emphasis in original)
Similarly, in In the Matter of Paragon Futures Association, et al., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) & 25,266 at 38,850 (CFTC Apr. 1, 1992), the Commission noted that "oral authorization which is not specific does not satisfy the requirements of Commission Rule 166.2." Accordingly, even though complainant orally gave Bakizada a general authorization to trade sometime in late 1992, that authorization did not satisfy the requirements of Rule 166.2. Accordingly, the lack of either written or specific authorization to trade renders Bakizada's trading unauthorized and constitutes violative conduct under Rule 166.2.
Moreover, there is no basis for a finding of ratification of the unauthorized trades. A customer ratifies unauthorized trading for his account "only where it is clear from all the circumstances presented that the intent of the customer was to adopt, as his own and for all time, the trades executed for his account without authorization." Sherwood v. Madda Trading Company, [1977-1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) & 20,728 at 23,020 (CFTC Jan. 5, 1979). The customer's adoption of such trading must be "clear and unequivocal." Sherwood, & 20,728 at 23,022. To determine whether there has been ratification, the Commission looks at the complainant's knowledge and activity after the disputed transaction occurs. In this case, complainant was apprised of the unauthorized trading by Bakizada's September 3, 1992 letter. Complainant stated that he was devastated by this information and contacted Bakizada to complain about the trades. (Tr. at 30.) This conduct makes clear that complainant did not intend to adopt these trades as his own, and therefore, no ratification of the trading occurred.
Complainant's decision to continue trading with Bakizada in late 1992 does not constitute a ratification of the unauthorized trades. The Commission has noted that it will look at the totality of circumstances regarding complainant's post-transaction conduct in determining whether ratification occurred. Sherwood, & 20,728 at 23,020. Inasmuch as it is clear that Bakizada lulled Kacem into continued trading by making an illegal guarantee to complainant, the complainant's subsequent trading did not reflect an acceptance by Kacem of the prior unauthorized trading.
Pursuant to Section 2(a)(1)(A)(iii) of the Act, 7 U.S.C. ' 2(iii) (1994), Castle may be held liable for the violative conduct of its employee Bakizada. Section 2(a)(1)(A)(iii) provides that:
[t]he act, omission, or failure of any official, agent, or other person acting for any individual, association, partnership, corporation, or trust within the scope of his employment or office shall be deemed the act, omission, or failure of such individual, association, partnership, corporation, or trust, as well as of such official, agent, or other person.
There is no dispute in this matter that Bakizada was registered as, and acted in, the capacity of an associated person of Castle. Moreover, it is clear that the conduct underlying this cause of action, that is, solicitation of and trading in a commodities account, was undertaken by Bakizada within the scope of his employment as an associated person of Castle. Accordingly, the requirements for assessing vicarious liability pursuant to Section 2(a)(1)(A)(iii) have been satisfied, and we therefore hold Castle liable for Bakizada's violation of Rule 166.2.
Violation of Rule 1.56
Rule 1.56 states in pertinent part:
No futures commission merchant or introducing broker may in any way represent that it will, with respect to any commodity interest in any account carried by the futures commission merchant for or on behalf of any person: (1) Guarantee such person against loss . . . .
The fact that a guarantee occurred in this case is supported by several factors. As noted above, Bakizada's September 3, 1992 letter states, in pertinent part:
I told . . . [a customer] that she shouldn't worry because I will personally guarantee her $10,000. But please, this is off the record, I am doing this as a friend. I will do the same with you if need be. Just don't worry, your money (and . . . [the other customer's]) as [sic] considered more important than my own. I have the confidence that I will succeed in making money for all of us.
Moreover, complainant testified that Bakizada had guaranteed his account. When the ALJ asked complainant if Bakizada had said anything about guaranteeing losses, complainant responded, "[y]eah. He said as I stated in my letter I want you to have confidence in me and your money is guaranteed. Don't worry. I have [sic] losses before and I'll make it up again." (Tr. at 31.) Complainant testified that he deposited more money in the account after September 1992 because he was "under the assumption that [Bakizada] was guaranteeing my money." (Tr. at 32.) Complainant continued to believe until April 1993 that his investment was guaranteed by Bakizada. (Tr. at 37.)
Additionally, Bakizada made a payment of $5,000 to complainant in February 1993. (Tr. at 57-60.) Complainant testified that this payment was made to him pursuant to Bakizada's guarantee against losses. (Tr. at 78.) Complainant indicated that he interpreted the guarantee as including Castle, because he had been told by Bakizada that he was an owner of Castle./ (Tr. at 113.) The combination of the guarantee language in the letter, the complainant's unrefuted testimony, and the February 1993 payment provide persuasive evidence that a guarantee was made in violation of Rule 1.56.
Pursuant to Section 2(a)(1)(A) of the Act, 7 U.S.C. ' 2(i) (1994), Castle is liable for the conduct of its employee Bakizada in offering such a guarantee. Accordingly, because we find that Bakizada violated Rule 1.56 while acting within the scope of his employment as an AP of Castle, we hold Castle vicariously liable for the violation.
Violation of Section 4b
Section 4b of the Act makes it unlawful "to cheat or defraud or attempt to cheat or defraud" a person in connection with trading in a commodity account. The Commission has held that proof of unauthorized trading in violation of Rule 166.2 constitutes a violation of Section 4b (see Slone v. Dean Witter Reynolds, Inc., [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) & 26,283 at 42,433 (Dec. 16, 1994), in which the Commission found that unauthorized trading created a "cause of action under Section 4b(a) and 4d of the Act as well as Commission Rule 166.2. . . .").
Moreover, there is significant evidence in this case to support the fact that complainant was fraudulently lulled into continued trading in his account after learning of Bakizada's unauthorized trading in August 1992 and the resulting losses. As discussed above, Bakizada offered to guarantee complainant against losses in order to induce him to continue to trade. He also reassured complainant that the losses would be recouped. Complainant testified, "[a]fter insisting that, you know, that my money's guaranteed and [Bakizada's] going to make it up and he's going to make me even more, so I put $10,000 in October." (Tr. at 33.) In response to this lulling, complainant deposited additional monies in the account, including the $5,000 that Bakizada paid to him as part of the guarantee.
Bakizada continued to trade the account through March 1993, despite heavy trading losses. Complainant testified that Bakizada continued to provide him during this period with assurances that the funds would be recouped through trading or, in the alternative, that Bakizada would reimburse complainant. (Tr. at 32, 33, 36.) In addition to forming the basis for the Rule 1.56 violation as noted above, the guarantee and the February 1993 $5,000 payment, combined with Bakizada's other fraudulent lulling activity, support a finding of fraud liability under Section 4b.
Pursuant to Section 2(a)(1)(A) of the Act, Castle is liable for such fraudulent behavior of its employee Bakizada.
Statute of Limitations
Castle did not file an answer in this case, but did raise a statute of limitations defense prior to trial. We find that the statute of limitations argument is not availing to Castle. Section 14 of the Act, 7 U.S.C. ' 18(a)(1)(A) (1994), requires that a reparations claim be filed within two years of the accrual of a cause of action. The Commission has held that a cause of action "accrues" when a complainant knows, or should have known in the exercise of due diligence, that wrongful conduct has occurred. Cook v. Monex International, Ltd., [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) & 22,532 at 30,295 (CFTC Mar. 19, 1985). The cause of action in this case arose when complainant became aware that he had been fraudulently lulled into not seeking his legal remedies. This awareness occurred either in March 1993, when complainant ceased the trading in his account, or in April 1993, when Bakizada reneged on the guarantee. Therefore, complainant's complaint filed in December 1994 is well within the two-year statutory period.
Complainant calculated his claimed damages as follows. He invested $38,000, which was increased prior to Bakizada's illegal unauthorized trading by gains of $23,275 as of July 31, 1992. From this total, complainant deducted $1,739, which was the remaining equity in his account when it was closed. He also deducted $5,000 which he received from Bakizada in February 1993 as part of the guarantee, as well as settlements of $2,000 from Bakizada and $20,000 from ING.
Section 14(a)(1)(A) of the Act, 7 U.S.C. ' 18(a)(1)(A) (1994), provides that a reparations damages award is to be the amount of actual damages caused by the violative conduct, which in this case consists of the amount complainant had in his account prior to the unauthorized trading in August 1992. (Tr. at 67.) We have held that "[r]eparations proceedings are primarily compensatory in nature, thus, the calculation of damages should focus on the out-of-pocket loss to the complainant which was caused by the unlawful act." Stiller v. Shearson, Loeb, Rhoades, Inc., [1982-1984 Transfer Binder] Comm. Fut. L. Rep. (CCH) & 21,789 at 27,155 (CFTC July 11, 1983). When the unauthorized trading in this account commenced in August 1992, complainant's account included his initial investment and substantial profits. The profits were no less his property than his initial investment and constitute part of his total damages. Accordingly, complainant is awarded damages from Castle in this case in the amount of $32,536, with pre-judgment interest on this amount calculated at the rate of 6.06 percent per annum from August 31, 1992 to the date of payment, plus $250 in filing fees.
IT IS SO ORDERED./
By the Commission (Chairperson BORN, and Commissioners DIAL, TULL, HOLUM, and SPEARS).
Jean A. Webb
Secretary of the Commission
Commodity Futures Trading Commission
Dated: May 20, 1997