UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
In the Matter of
DAVID ROUSSO, NEIL T. MCGOLDRICK,
CFTC Docket No. 91-3 RICHARD HENRIKSEN, and WILLIAM J. REIDY,
This appeal arises out of a multi-count complaint filed in 1991 by the Division of Enforcement ("Division") which focused on a series of alleged trade practice violations affecting the New York Mercantile Exchange's ("NYMEX") crude oil contracts. Respondents essentially were charged with operating a noncompetitive trading network in the crude oil pit for their own profit and at the expense of customers.
After evaluating the record developed by the parties, the Administrative Law Judge ("ALJ" or "judge") found the respondents liable for 143 noncompetitive futures transactions alleged in the complaint but dismissed trading ahead charges against respondent Rousso for failure of proof. The judge's choice of sanctions included registration suspensions, trading prohibitions, and civil money penalties.
Respondents raise both procedural and substantive challenges to the ALJ's decision, contending among other things that the judge denied them a fair hearing, made liability findings based on suspicious circumstances rather than direct or circumstantial evidence of respondents' knowing participation in unlawful transactions, and imposed excessive sanctions. The Division appeals the ALJ's dismissal of the trading ahead charges against respondent Rousso and urges the imposition of more stringent sanctions on all the respondents.
Based on our independent assessment of the record, we conclude that the record supports the ALJ's liability findings. Moreover, we find that the ALJ did not err in his procedural rulings. However, we find that the trading abuses for which respondents are liable warrant the imposition of more stringent sanctions than those chosen by the ALJ. Accordingly, we modify those sanctions and impose appropriate registration revocations and trading prohibitions in addition to the civil monetary penalties assessed by the judge.
The Division's Complaint
From June through November 1988, the time period covered by the complaint, respondents were among the most active traders in the NYMEX crude oil pit.(1) Rousso and McGoldrick were dual traders who executed customer orders for RIS Commodities, Inc. and traded for their personal accounts. Henriksen and Farley, also dual traders, executed customer orders for Gerald, Inc. Reidy, a "local," traded only for his personal account.
On January 28, 1991 the Commission issued a complaint charging the respondents, Kathleen Farley, Ris Commodities, Inc., and Gerald, Inc.(2) with multiple violations of Sections 4b, 4c(a) and 4g of the Commodity Exchange Act ("CEA" or the "Act"), 7 U.S.C. §§ 6b, 6c(a), and 6g (1988), and Commission regulations 1.31(a)(1) and 1.35(a), 17 C.F.R. §§ 1.31(a)(1) and 1.35(a). Respondent Rousso was additionally charged with trading ahead of his customers' orders in violation of Section 4b(A) of the Act, 7 U.S.C. § 6b(A).(3)
A number of the transactions were described in the complaint as "noncompetitive executions of customer orders" by Rousso, McGoldrick, Henriksen, and Farley opposite each other and Reidy. These trades allegedly took the form of direct and indirect bucketing (118 sequences), trading opposite customer orders (ten sequences), illegal offsets (12 sequences), and money passes (three sequences). In seven sequences identified in the complaint, respondent Rousso was charged with trading ahead of his customers' orders in violation of Section 4b(a) of the Act.
As described in the complaint, in respondents' indirect bucketing scheme, one respondent trading as a floor broker would execute a customer order on one side of the market and trade for his or her personal account on the other side, with both trades done at or near the same price opposite another respondent. In the "trading opposite" sequences, a respondent would arrange to trade for his or her personal account opposite customer orders transmitted to an affiliated broker through RIS or Gerald. In 12 sequences, Rousso, McGoldrick, Henriksen, or Farley simultaneously held customer orders to buy and sell contracts for the same month. They illegally "offset" the orders by executing them noncompetitively with Reidy (or with one of the four acting as a local), enabling the local to realize a profit and depriving the customer of the competitive execution of his order. In each of the "money pass" sequences a respondent trading for his own account noncompetitively bought and sold identical quantities of the same future opposite another respondent at a price difference, which allowed one respondent to pass money to the other in the form of trading profits. In the seven alleged "trading ahead" sequences, the Division charged that Rousso held executable customer orders while trading for his own advantage at the expense of the customer.
Prior to the administrative hearing, the Division sought and the ALJ granted summary disposition on behalf of the Division on the recordkeeping charges in Counts Seven and Eight of the complaint.(4)
During the prehearing period, the Commission accepted offers of settlement from RIS and Gerald, Inc. on charges that they violated Commission Regulations 1.31(a)(1), 1.35(a) and 166.3, 17 C.F.R. § 166.3. The Commission also accepted an offer of settlement from Kathleen Farley, in which she consented to the findings as charged and undertook to testify truthfully at any hearing on the case.(5) Farley met with Division staff twice prior to the hearing to provide them with her comments and opinions with respect to the 43 trades in which she participated.(6) In its prehearing memorandum, the Division advised that Farley would testify generally that she had participated in noncompetitive trading with the remaining respondents, but would be unable to testify whether some of the charged trades were executed noncompetitively.
Both the Division's expert witness and the expert designated by respondents provided detailed verified statements in advance of the hearing.(7) Elizabeth Hastings, a Division senior staff investigator, described the challenged trades and the bases for her opinion that these trades were noncompetitively executed. Through an analysis of the records made by respondents and the NYMEX during the six-month period covered by the Division's investigation,(8) Hastings identified in respondents' trading "a pattern of buying and selling the same contract opposite the same trader or affiliated traders at or about the same price." Verified Statement of Elizabeth Hastings ("Hastings") at 26. In her opinion, such trading would, depending on the circumstances, permit the respondents to gain an advantage over the market by (1) profitably offsetting an existing position; (2) reducing the size of an existing position before the market closed; (3) minimizing a loss; or (4) establishing a position that might not be possible through competitive trading.
In most of these sequences, one trade was to fill a customer order and the other trade was for the broker's personal account. In such instances the trades appeared within a few lines of each other on the opposite trader or broker's trading card. Occasionally, Hastings noted two customer orders offset at advantageous prices to the opposite trader or broker, and those trades would be recorded within a few lines on each of the trading cards of both participants. In those instances where an affiliated broker took the opposite side of a broker's customer order, the trades were recorded in close proximity on the affiliated broker's trading card. More than half of the charged trade sequences were characterized by these or other "indicia of noncompetitive execution"(9) that added weight to the inference of noncompetitive trading drawn from the pattern.
As a separate matter, Hastings reconstructed each of the seven alleged trading ahead sequences attributed to Rousso and concluded, on the basis of the audit trail, that in each instance Rousso traded for his own account while holding an executable customer order, in each case obtaining a better price for himself than the trade that filled his customer's order. In analyzing these sequences, Hastings relied on floor order timestamps, office order timestamps, the sequence of trades on Rousso's trading cards, NYMEX time and sales data and, in some instances, an opposite trader's sequence of trades. She also relied on information provided by Rousso regarding his usual practice of recording trades, preparing pit cards, and "other business practices." Hastings at 8.
Respondents' expert, John Schobel, formerly an assistant director of the Commission's Division of Trading and Markets, a floor broker, and a vice president of the New York Coffee and Sugar Exchange, disagreed with Hastings' conclusion that the challenged trades had been executed noncompetitively. In his verified statement, Schobel explained that the pattern described by the Division was neither unusual nor suspicious in the context of trading in the crude oil pit. Schobel, Verified Statement at 21-26 ("Schobel"). According to Schobel, in a one-point market such as crude oil, brokers, local traders, and dual traders frequently buy and sell at the same price with each other.(10) Schobel at 18-21, 48. Thus, in his opinion, no inferences could be drawn from the pattern described by Hastings. Moreover, he opined that the audit trail irregularities cited by Hastings were unreliable indicia of noncompetitive execution and were more likely the result of human error, mechanical failure, and chaotic conditions in the crude oil pit. Schobel pointed out that during the period in question, NYMEX had no sequencing rule, no rule prohibiting multiple submissions of pit cards, and no prescribed methods for writing or correcting pit cards. Pit cards frequently missed the net, he testified, and 15 to 20 percent of cards were submitted late.(11) Tr. 62, 93, 136. Schobel also cited a report on rule enforcement procedures at the NYMEX prepared by the Commission's Division of Trading and Markets ("T&M") which rated the accuracy of the NYMEX pit card system from December 1989 to May 1990 at 79.7 percent. Schobel at 33-37.
In October and November of 1992, a hearing was conducted on the charges not disposed of by summary disposition. To the analysis of its expert, the Division added the testimony of Kathleen Farley, the settling respondent, and NYMEX compliance official William Morrisey.
Farley testified that during the relevant time period she was a dual trader executing customer orders for Gerald, Inc. Her normal position in the NYMEX crude oil pit placed her in close proximity to the respondents. While she was unable specifically to recall the noncompetitive trades attributed to her, she testified that she had executed customer orders noncompetitively opposite respondents approximately four to six times a week and that she agreed to trade for her own account noncompetitively opposite Rousso and McGoldrick directly and indirectly through a scheme involving all the respondents.(12) She also stated that on some occasions she had both seen and heard Reidy agree to do noncompetitive trades for Rousso and McGoldrick. Tr. 187, 195-96.(13) In an attempt to discredit Farley's testimony, respondents requested that the Division produce the notes taken during its pre-hearing meetings with Farley. Following an in camera inspection, the ALJ determined that the Division's notes were not producible under Commission Rule 10.42(b), 17 C.F.R. § 10.42(b).(14)
The Division offered the testimony of William Morrisey to authenticate and explain various NYMEX documents, including pit cards, the time and sales register, and the street book, and to explain NYMEX rules in effect at the time of respondents' alleged noncompetitive trading. Morrisey also was asked by the Division to describe the NYMEX audit trail and explain how it was used by exchange compliance personnel to identify suspicious trading. Asked to comment on the pattern described by the Division, Morrisey stated:
My experience is that that's not a normal occurrence in trading. Brokers don't trade both the buy and sell with the same party. Whenever you see buying and selling involving the same parties, that's suspicious.
Tr. 47. According to Morrisey, it was also suspicious when a trader submitted late pit cards, received a better price for a personal account than for a customer order within a short time span, executed a purchase or sale for a customer and an equal sale or purchase for himself opposite the same broker, or executed such a trade sequence with the second leg split into two parts. Tr. 31, 33, 35.(15)
Respondents challenged Hastings' qualifications as an expert, her analytic methods, and the inferences she drew. Each respondent testified generally as to his trading practices and the trading conditions in the crude oil pit, emphasizing that chaotic conditions prevalent in the pit would affect normal trading practices. In addition, they presented two witnesses who corroborated elements of their testimony. Reubin Oliver, a former NYMEX floor reporter, described deficiencies in the reporting system during the relevant time period, noting that not all price changes and trades were reported and that time and sales reports neither accurately recorded the exact sequence of price changes in the pit nor accurately reflected all price changes. Tr. 963-64. Edward Lee, Vice President of the Energy Futures Division at Kidder, Peabody and Co., testified that he monitored Rousso's trading activity on behalf of Kidder and never saw any improper trading by any of the respondents. Tr. 1360, 1362.
Subsequent to the hearing, Farley on January 19, 1993, executed an affidavit modifying in part her hearing testimony concerning specific trade sequences attributed to her (the "Farley Affidavit"). Respondents at that time moved to reopen the hearing record for the limited purpose of admitting the Farley Affidavit into evidence. The ALJ denied their request on October 27, 1993. Following the issuance of the Inititial Decision and the parties' notices of appeal, respondents filed a joint motion requesting that the Commission reopen the record pursuant to 17 C.F.R. § 10.107 to admit the Farley affidavit.
The Initial Decision
The ALJ endorsed the liability analysis advanced by the Division with respect to the 143 noncompetitive transactions, concluding that the Division's explanation of the transactions was "more plausible in all respects than the explanation offered by the respondents." Initial Decision at 11. Specifically, the judge found that the pattern of trading was more plausibly explained by Hastings' inference of a noncompetitive trading scheme than by "coincidence" and that the audit trail was sufficiently reliable to permit inferences to be drawn from the documents. In this regard, the judge credited Morrisey's corroborating testimony that the pattern was suspicious as well as his general description of suspicious audit trail data. In evaluating Farley's testimony, the ALJ found that her admission of noncompetitive trading with the respondents during the relevant time period, "while not direct evidence that any particular trade was prearranged, when added to the other circumstantial evidence. . . creates a high probability that the trade sequences identified by the Division were the result of prearrangement." Initial Decision at 27-28.
The judge expressly endorsed the Division's theory with respect to respondents' motive for engaging in noncompetitive trading. He dismissed McGoldrick's and Henriksen's contention that the Division failed to identify a logical or consistent motive and Rousso's argument that he would not risk a successful and lucrative career by engaging in prohibited transactions that would yield little or no profit. Instead, the ALJ concluded that, with the exception of Reidy, respondents' motive was financial gain, which they achieved by using customer orders to their advantage to obtain a better price for their personal trades: "there can be little doubt that the accumulation of small profits over a lengthy time period can result in significant gains to a broker." Initial Decision at 25-26. While Reidy claimed that, as one of the most active traders in the pit, he had no motive to accommodate the other respondents' trades, the ALJ found that recognition from these high-volume traders was essential to Reidy's success. Initial Decision at 26.
Having found that the Division established a prima facie case of noncompetitive trading, the judge turned to the evidence offered for the trading ahead charges against respondent Rousso. He observed at the outset that, because these trades did not conform to a pattern, liability turned primarily on the audit trail evidence. By way of illustration, the ALJ analyzed the experts' reconstruction of Rousso Trade 41. In Hastings' opinion, both the timestamps and the sequencing of the trades on Rousso's trading card indicated that he held a customer order while executing a trade for his own account at a better price. Schobel had suggested that the entries on Rousso's trading card might have been out of sequence because of chaotic trading conditions. Moreover, Schobel emphasized that the risk to Rousso of a potential loss of $16,000 in the form of a customer adjustment far outweighed the alleged profit of $500. The ALJ concluded that "there is not a preponderance of evidence to show what likely occurred in this or any of the other five trading sequences identified by the Division. The audit trail is susceptible to multiple interpretations, each as plausible as the next." Initial Decision at 32-33. In the absence of additional evidence on these trades, the ALJ concluded that the Division had failed to prove trading ahead and, accordingly, dismissed the trading ahead charges against Rousso.
Based on his review of the evidence and his own analysis of the trades,
the ALJ concluded that all the respondents "knowingly associated
themselves with the 'shadow market' and sought by their actions
to make it succeed." Initial Decision at 29. He found Rousso liable
in 86 trading sequences (including 14 as an accommodator); McGoldrick
liable in 48 trading sequences (17 as an accommodator); Henriksen liable
in 40 trading sequences (12 as an accommodator); and Reidy liable in 83
trading sequences (all as an accommodator). Id. Noting that trade
practice violations of the type committed by these respondents damage the
integrity of the market and seriously erode the public's confidence
in the commodity futures industry, the ALJ suspended respondents'
registrations, prohibited them from trading, and ordered each to pay a
civil monetary penalty.(16) These appeals
Respondents focus their appeals on alleged flaws in the ALJ's liability analysis, his choice of sanctions and alleged procedural inequities in his conduct of the hearing and his summary disposition of the recordkeeping charges against some of the respondents. The Division appeals the ALJ's dismissal of the trading ahead charges against Rousso and urges the imposition of more stringent sanctions on respondents for their trade practice violations.
Respondents allege that the ALJ's bias in favor of the Division and his conduct of the hearing deprived them of a fair trial. They allege several errors: (1) the ALJ unduly restricted their cross examination of the Division's expert, particularly with respect to such matters as her qualifications, expertise and analytic methods; (2) Morrisey, the NYMEX official, was permitted to testify as an expert without proper designation and without having provided a written declaration as required by the ALJ's prehearing order; and (3) the judge credited Farley's testimony despite the Division's breach of its disclosure obligations under Commission Rule 10.42(b).
The ALJ limited respondents' cross-examination of Hastings to matters discussed in her written testimony. Respondents contend that this restriction improperly prevented them from questioning the Division's key witness about her qualifications as an expert, her credibility, and the bases for her inferences and conclusions, thus denying them a full and fair hearing. The qualifications of a witness to testify as an expert and the scope of cross examination are matters largely left to the fact finder's discretion.
The right to cross-examine a witness does not mean that a party can do so in "whatever way, and to whatever extent" it desires. Douglas v. Owens, 50 F.3d 1230 (3d Cir. 1995). Rather, a party is guaranteed only "an opportunity for effective cross examination," and the trier of fact may properly exercise its discretion to impose reasonable limits on the scope of cross examination. Id.; see also Maatschappij, 590 F.2d at 421; Air Disaster at Lockerbie, Scotland on 12-21-88, 37 F.3d 804, 825 (2d Cir. 1994). Thus, the question is whether the ALJ's decision to limit the scope of questioning so prejudiced the substantial rights of the respondents that it amounted to an abuse of discretion.
Our review of the testimony indicates that the ALJ restricted the cross-examination of Hastings because respondents' counsel repeatedly attempted to ask Hastings to compare her own qualifications with those of respondents' expert. That subject had limited relevance to the adequacy of Hastings' own qualifications, and the questioning may have been designed to embarass or harrass the witness.
We find that the ALJ quite properly curtailed such questioning and ruled that Hastings had been properly qualified as an expert. Hastings had been employed as an investigator in the Division of Enforcement since 1983 (except for one year during which she was employed in a similar capacity at the Securities and Exchange Commission) and had extensive experience in the investigation of trade practice cases. (17)
As to their ability to probe Hastings on other possible theories of causation, absent a good faith showing by respondents that these theories or omissions had evidentiary support, the ALJ's decision to limit this line of questioning was not improper. Air Disaster at Lockerbie, 37 F.3d at 825; Trademark Research Corp. v. Maxwell Online, Inc., 995 F.2d 326, 339 (2d Cir. 1993). The respondents were permitted a full opportunity to expose any weaknesses in Hastings' conclusions through their own expert's testimony. Furthermore, many of the points that respondents attempted to establish through cross examination of the Division's expert, e.g., the chaotic conditions in the crude oil pit, were already established through direct testimony. Other points, such as information provided by Farley regarding specific trades, were based on material that was not part of Hastings' Verified Statement and, as the Division pointed out, could have been elicited from Farley before or during the hearing. Tr. 287. Based on our review of the record, we are satisfied that the limitations on cross examination of Hastings were appropriate and did not prejudice the respondents. Accordingly, we conclude that the ALJ's rulings in this regard were reasonable in the circumstances and did not deny respondents a fair hearing.
Respondents also contend that the ALJ committed reversible error in allowing James Morrisey, whom the Division did not designate as an expert witness, to testify as an "expert" insofar as he testified concerning suspicious trading patterns. The Division counters that Morrisey merely testified as to his general opinion based on his personal knowledge of trade practices and that opinion testimony is not limited to experts, U.S. v. Garcia, 994 F.2d 1499, 1506 (10th Cir. 1993).(18) Clearly, as a NYMEX compliance officer, Morrisey had sufficient knowledge to testify about the types of trading floor practices considered suspicious by the NYMEX compliance department. The ALJ was able to weigh the value and credibility of this evidence properly. Cf. Teen-Ed v. Kimball International, Inc., 620 F.2d 399, 403 (3d Cir. 1980). Furthermore, the respondents were provided an opportunity to cross-examine Morrisey and have not demonstrated any prejudice they suffered as a result of his testimony. Given the general nature of Morrisey's testimony and respondents' failure to demonstrate any prejudice, we conclude that the ALJ committed no reversible error in permitting Morrisey's testimony.
During the hearing, the ALJ denied respondents' Rule 10.42(b) request for production of notes taken by Division staff during its prehearing discussions with Kathleen Farley. The ALJ determined that the notes were not producible under the Jencks Act, 18 U.S.C. § 3500, Commission regulations, or the dictates of Brady v. Maryland, 373 U.S. 83 (1963). On appeal, respondents submit that Farley's testimony should be stricken because the Division was required to provide the notes under Commission Rule 10.42(b) as exculpatory evidence. Essentially, respondents contend that the Division misled them by failing to disclose that Farley had advised the Division that she believed that 12 trades identified in the complaint were properly executed.
Farley provided the Division with a signed statement dated October 14, 1991, concerning the noncompetitive nature of trades in which she had engaged with each of the respondents and the fact that she had no recollection of certain trades. Consistent with its Brady, Jencks, and Rule 10.42(b) obligations, the Division supplied respondents with this statement and a summary of Farley's anticipated testimony. The Division's Prehearing Memorandum also informed respondents that Farley would testify that she was "unable to state" that twelve trade sequences were executed noncompetitively. Respondents argue that this disclosure did not adequately alert them to its exculpatory nature. However, the disclosure statement provided adequate notice to respondents that Farley either had insufficient information to testify that those 12 trades were illegally executed or believed that they were properly traded. In these circumstances, respondents had a duty to examine Farley about those trades. In re First National Monetary Corp., [1982-1984 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 21,853 at 27,582 (CFTC Nov. 13, 1981); In re First Guaranty Metals Co., [1980-1982 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 21,074 at 24,341 (CFTC Nov. 13, 1980). The Commission's Brady obligations do not require it to furnish material that a respondent already has or can easily obtain with reasonable diligence. In re First National Monetary Corp, ¶ 21,853 at 27,582. The record indicates that respondents did not attempt to interview Farley prior to the hearing in order to clarify her statements, nor did they pursue the matter at the hearing, either through cross-examination or, as the ALJ suggested, by calling Farley as their witness. Tr. 160-209, 213-18, 291.(19) As respondents took no action either prior to or during the hearing to ascertain the meaning of Farley's statement, they can hardly be said to have exercised the requisite reasonable diligence. Furthermore, we have decided not to rely on the 12 trades that are the subject of respondents' disclosure argument in determining the respondents' liability, and thus the respondents clearly have suffered no prejudice.(20)
As noted, prior to the hearing, the ALJ granted the Division's motion for summary disposition of the recordkeeping and timestamp violations alleged in Counts Seven and Eight of the complaint against Rousso, McGoldrick, Henriksen, and RIS. On appeal, respondents Rousso and McGoldrick argue that the ALJ erred in granting the Division's motion with respect to Count Seven. The recordkeeping violations alleged by the Division centered on respondents' failure to produce floor order tickets for certain dates in response to a Division subpoena duces tecum. Rousso failed to submit cards for six dates in 1988, McGoldrick for two dates. These respondents contend that no violation should have been found because the missing cards represented an insignificant portion of their records. Moreover, they assert that no violation should have been found because NYMEX rules in effect at the time did not require the maintenance of trading cards. Both arguments were made below and discussed by the ALJ, who observed that neither the Act nor relevant Commission regulations recognize a "de minimis exception" for recordkeeping violations and that respondents were responsible for compliance with Commission regulations regardless of NYMEX rules. Order dated June 17, 1992 at 8. Rousso further argues that summary disposition was improper because there was a question of fact whether Rousso failed to maintain trading records. Appeal Brief of Respondent Rousso at 54-55. However, he acknowledges that "some trading cards were not found." Id. at 7. This argument suggests that the Commission should recognize a good faith effort by respondents to maintain their records. Regulation 1.31, however, requires all records to be maintained. Once respondents conceded that some records were missing, the facts establishing recordkeeping violations became undisputed. In such circumstances, summary disposition is appropriate. See In re Antonacci, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,038 at 32,066 (CFTC Apr. 21, 1986).
Respondents argue on appeal that the ALJ failed to accord appropriate weight to the plausible explanations they advanced for the challenged trades. They contend that the basic flaw in the ALJ's trade practice analysis is his acceptance of the Division's theory that trading patterns are a sufficient basis for the factual inferences necessary to establish liability under the weight of the evidence standard. Further, they challenge the reliability of the inferences drawn from the patterns, contending that the patterns are equally consistent with lawful dual trading among large traders in the crude oil pit. With respect to the audit trail irregularities, respondents assert that "Hastings simply selected, and the ALJ adopted, several different aspects of Respondents' imprecise (but legal) record keeping practices and unilaterally designated them as 'audit trail irregularities.'" Appeal Brief of Richard Henriksen at 20. Respondents contend that none of these irregularities had probative value and each was explained by human error, mechanical failure and inadequacies in the audit trail system.
1. The Noncompetitive Trades.
An analysis of trading patterns and audit trail evidence may be the basis for establishing noncompetitive trading. Buckwalter, ¶ 24,995 at 37,684; In the Matter of Rosenberg, [1990-92 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,992 at 37,643 (CFTC Jan. 25, 1991). The Commission has found that in appropriate circumstances a pattern marked by characteristics unlikely to occur in an open and competitive market was indicative of noncompetitive trading. Buckwalter, ¶ 24,995 at 37,682-83; Bear Stearns, ¶ 24,994 at 37,663. Moreover, the existence of such a pattern permits the inference that the trades that form the pattern were intentionally achieved by noncompetitive means. See In re Collins, [ 1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,982 at 31,900 n.16 (CFTC Apr. 4, 1986); and In re Gimbel, [1987-90 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,213 at 35,003 n.6 (CFTC Apr. 14, 1988), aff'd as to liability, Gimbel v. CFTC, 872 F.2d 196 (7th Cir. 1989). To succeed in a circumstantial approach, however, the Division must do more than present suspicious circumstances suggesting the possibility of knowing wrongdoing. It must establish that "the existence of these factual elements is more probable than their nonexistence." Lobb v. J.T. McKerr, [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,568 at 36,443 (CFTC Dec. 14, 1989); Rosenberg, ¶ 24,992 at 37,643. Accordingly, our focus on review is whether the cumulative evidence offered by the Division establishes that it is more likely than not that the respondents engaged in noncompetitive trading.
The Division's expert identified repeated instances of trading in which respondents traded opposite each other at about the same price and about the same quantity within a very short period of time.(21) Both Hastings and Morrisey testified that this pattern of trading results is unlikely to occur in competitive trading. Schobel contended that the pattern described by the Division is consistent with legitimate trading in the crude oil pit, but did not explain why trading in crude oil is so significantly different from other NYMEX trading that the Division's inferences do not apply.
Moreover, in this case the direct testimony of Kathleen Farley confirms the inferences drawn by the Division. Farley stated that she agreed to trade noncompetitively with these respondents, did so on a regular basis, and observed respondents trade noncompetitively with each other. This testimony tends to exclude the possibility that respondents' suspicious trading patterns were the result of independent action or coincidence. Cf. First National Bank of Arizona v. Cities Service Co., 391 U.S. 253, 280 (1968); Matsushita Electric Industrial Co., Ltd., et al. v. Zenith Radio Corp. et al., 475 U.S. 574, 588 (1985). Farley's testimony provides direct evidence that the respondents traded noncompetitively and had agreed to do so. The Division's pattern evidence supports that testimony and, taken with it, demonstrates the illegality of the challenged trades.
Respondents criticize the NYMEX audit trail, and inferences drawn from that data, as unreliable. We agree that audit trail irregularities, standing alone, may have limited evidentiary value when viewed in the context of NYMEX rules and procedures during the relevant period because of the difficulty in distinguishing deliberate obfuscation from random error. Audit trail irregularities such as late trades, altered trading cards and contradictory sequencing take on evidentiary significance, however, when considered in the context of the pattern evidence and Farley's testimony and further add to the weight of the evidence supporting the ALJ's findings.
Based on our review of the evidence, we affirm the ALJ's finding that respondents knowingly participated in a noncompetitive trading scheme in violation of sections 4b(A), 4b(C), 4b(D), 4c(a)(A) and 4c(a)(B) of the Act and Commission regulation 1.38(a). Moreover, we agree with the judge's conclusion that all the respondents knowingly associated themselves with the scheme and sought by their actions to make it succeeed. In re Richardson Securities, Inc., et al., [1980-1982 Transfer Finder] Comm. Fut. L. Rep. (CCH) ¶ 21,145. Accordingly, we also affirm the ALJ's finding that all respondents aided and abetted the violations and are thus liable as principals pursuant to section 13(a) of the Act, 7 U.S.C. § 13c(a).
2. The Trading Ahead Charges.
Trading ahead occurs where a dual trader intentionally buys or sells for his or her own account while holding an executable customer order, thus taking the same side of the market as his or her customer with the result that the trade cleared for his or her personal account is at a better price than the trade that filled his or her customer's order. Evidence of timing is essential to proving a trading ahead violation; the Division must show that the trader held an executable customer order while executing trades for his or her own account.
Both the Division and Rousso reconstructed and analyzed each of the alleged trading ahead sequences on the basis of the audit trail. The Division relied on the sequencing of trades on Rousso's trading cards to prove that he traded for his own account while holding an executable customer order. Rousso offered explanations for the sequencing of these trades. After reviewing the audit trail data and the parties' explanations for each of the six sequences, the ALJ was unable to conclude whether Rousso had traded ahead of his customers.
As discussed above, during the period and in the market in question, the kind of audit trail irregularity relied on by the Division to prove trading ahead may, standing alone, be insufficient to prove a trading violation. Discrepancies between time and sales and the sequencing of trades on Rousso's card may reflect that Rousso did not have a timestamped customer order in hand when he traded for his own account or that he was unable to execute at the limit as well as indicate illegal trading. Because the ALJ found that Rousso's explanations with respect to these trades were as plausible as the Division's, the ALJ correctly concluded that the Division did not carry its burden to prove such violations by Rousso by the weight of the evidence. Accordingly, we affirm the ALJ's dismissal of these charges.
Each of the respondents claims on appeal that, even assuming liability, the sanctions imposed by the ALJ are excessive. Rousso asserts that the sanctions imposed on him were excessive and were determined without the benefit of a well reasoned and factually detailed analysis. Reidy argues that, in light of his role as an accommodator who did not personally profit from the challenged trades, the magnitude of his fine and suspension are unnecessary to insure the integrity of the market. Reidy Brief at 55. McGoldrick describes the sanctions imposed on him as "draconian" and unreasonable in light of the violations and his subsequent clean record. McGoldrick Brief at 54-55. Claiming a negative net worth of $430,000 and an income one-sixth of McGoldrick's, Henriksen argues that his $100,000 penalty and six-month suspension are "grossly excessive," especially in light of his clean record. Henriksen Brief at 42-43. Of the four respondents, only Henriksen requested a hearing to determine appropriate sanctions in light of his net worth. Henriksen Responding Brief at 3.
In contrast, the Division describes the ALJ's choice of sanctions as "clearly inadequate" and urges the Commission independently to assess the record and to impose a level of penalties significantly higher than those selected by the ALJ. Appeal Brief of the Division of Enforcement at 41-43. Specifically, the Commission is urged (1) to revoke respondents' floor broker registrations; (2) to impose permanent trading prohibitions; and (3) to increase Rousso's civil penalty to $350,000 and to penalize each of the remaining respondents $300,000.
Sanctions in CFTC enforcement proceedings are imposed to "further the Act's remedial policies and to deter others in the industry from commiting similar violations." In re Volume Investors Corp., [1990-92 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,234 at 38,679 (CFTC Feb. 10, 1992). In determining what measure of sanctions is commensurate with the gravity of the violation, the Commission is not limited by the penalties chosen in the initial decision, but exercises its independent judgment. In re Grossfeld, et al., [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,921 at 44,467 (CFTC Dec. 10, 1996). The Commission does not rely on a specific formula in assessing de novo the appropriate level of sanctions, but instead focuses on the relative gravity of a respondent's particular misconduct in light of the following factors: (1) the relationship of the violation at issue to the regulatory purposes of the Act; (2) the respondent's state of mind; (3) the consequences flowing from the violative conduct; and (4) respondent's post-violation conduct. In addition, the Commission considers any mitigating or aggravating circumstances presented by the facts. Id. at 44,467-68.
In the instant case, these respondents routinely and repeatedly engaged in noncompetitive trading to the detriment of customers. Rousso, McGoldrick and Henriksen, aided and abetted by each other and by Reidy, cheated and defrauded their customers, deceived customers in connection with the execution of their orders, bucketed customer orders, and filled customer orders illegally by offset. Initial Decision at 28-29. All of the respondents traded noncompetitively and, aided and abetted by each other, entered into wash sales, fictitious sales and accommodation trades and caused non-bona fide prices to be reported. Initial Decision at 29. They created a "shadow market" using customer orders to their advantage to obtain a better price for their personal trades. Id. at 25. Such violations, as the ALJ observed, tend to damage the integrity of the market and to seriously erode public confidence in the commodity futures industry. Id. at 33.
We reject respondents' argument that their customers were not harmed because they received the price they asked for. Customers may request that their orders be filled at a certain price. However, futures markets, when they operate fairly by open outcry, act to "discover" the true market price, which might be better for the customer than the order price. Failure to pursue the best price possible can, without more, constitute fraud regardless of whether the customer is harmed financially. U.S. v. Ashman, 979 F.2d 469, 477-8 (7th Cir. 1992); cf. In re Crouch, Docket No. 93-10, slip op. at 13; In re Mosky, slip op. at 18.
1. Registration revocation. Because their violations involve fraud, respondents are subject to statutory disqualification from registration pursuant to Section 8a(2)(E) of the Act. In re Gordon, [ 1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,667 at 40,181 (CFTC March 16, 1993); In re Shelton [1992-94 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,332 at 39,086 (CFTC July 14, 1991). The gravity of respondents' offenses supplies the foundation for imposing the most stringent possible sanctions; their violations of the antifraud provisions of the Act establish prima facie that respondents' registrations should be revoked. Shelton, ¶ 25,332 at 39,086. Additionally, the record indicates that respondents' offenses were not isolated incidents but part of a pattern of illegal trading practices. Such a pattern of conduct establishes a strong likelihood that the wrongdoing will be repeated. Cf. In re Mosky, Docket No. 91-19, slip op. at 18 (CFTC June 25, 1997). In these circumstances, revocation of registration is entirely appropriate for serious trade practice violations such as those committed by these respondents:
[P]articipation in prearranged trading, apart from being a violation of law, breached the duty that commodity professionals owe, not only to the futures market but also to those who rely upon their bona fides. . . . 'Congress invested the Commission with revocation power to safeguard the public interest in the well being of the nation's commodity futures markets.' [citation omitted] To insure against such conduct in the future and to serve as a warning to others, we conclude that the public policies of the Act can best be served by revocation not merely suspension of registration as a floor broker.
In re Sundheimer, [1980-1982 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 21,245 at 25,220 (CFTC Sept. 16, 1981); aff'd Sundheimer v. CFTC, 688 F.2d 150 (2d Cir. 1982).
In challenging the severity of the sanctions imposed by the ALJ, respondents essentially argue that, even if guilty, the severity of their violations is mitigated by their clean post violation records. Clean records after the fact, without more, are not sufficient to rebut the presumption of unfitness for registration. The inference of a "changed direction" is undercut by the fact that respondents were subject to an outstanding adiminstrative complaint. As we have previously noted, the weight accorded such evidence must be limited in these circumstances. In re Silverman, [1977-1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 20,410 at 21,643 (CFTC Mar. 14, 1977), aff'd sub nom. Silverman v. CFTC, 562 F.2d 432 (7th Cir. 1977); In re Mosky, slip op. at 22. Thus, respondents have failed to offer clear and convincing evidence of mitigation or rehabilitation as required by law. In re Antonacci, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,835 at 36,930 (CFTC April 18, 1990); In the Matter of Commodities International Corporation, et al., Docket No. 83-43, CFTC Jan. 14, 1997; In re Tipton, [1977-1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 20,673 (CFTC Sept. 22, 1978). In these circumstances, and in light of the gravity of their fraudulent conduct, we believe the public interest warrants revocation of respondents' registrations.
2. Trading Prohibitions. The Commission articulated standards for establishing trading prohibitions in In re Citadel Trading Co. of Chicago, Ltd., [1986-87 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,082 (CFTC May 23, 1986). The factors to be considered in imposing a contract market trading ban and the length of such a ban include the existence of a nexus between the violation and the integrity of the futures market and, if such a nexus is found, a correlation between the gravity of the offsnse, the length of the ban and the impact the ban will have on the respondent. Where, as here, the proven offenses directly abuse the respondents' market trading privileges, the nexus requirement is met. In re Murphy, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,798 at 31,355 (CFTC Sept. 25, 1985).
More recently, the Commission has held that a ban is appropriate when there is "an injury to the integrity of the market in the public eye." In re Miller, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,440 (CFTC June 16, 1995) (quoting Monieson v. CFTC, 996 F.2d 852, 863 (7th Cir. 1993)). The respondents' offenses represent repeated and direct assaults on the integrity of the marketplace and erode public confidence in futures markets. Respondents' repeated fraud against their customers presents a likelihood of a continuing risk to the market and meets the standard set forth in Miller. Because of the seriousness of this risk, we impose a ten year trading ban on each of the respondents.
3. Civil Monetary Penalties. All respondents criticize as excessive the civil penalties imposed by the ALJ.(22) In setting these penalties, the ALJ did not discuss respondents' net worth.(23) With the exception of respondent Henriksen, none of the respondents has, at any stage of these proceedings, requested a net worth hearing or furnished any financial statements. In light of the gravity and number of charges against these respondents, they or their counsel should have anticipated that civil monetary penalties would be imposed and should have requested a net worth hearing, if one was desired. Accordingly, we treat the issue of their net worth as waived by Rousso, McGoldrick and Reidy. As to Henriksen, we hereby order him to show cause, within 30 days of the date of this Order, why the civil penalty imposed against him should be modified in light of his net worth.
Sanctions imposed in an enforcement proceeding should be commensurate with the gravity of the violation, In re Brody, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,081 at 32,181 (CFTC May 20, 1986). Serious violations warrant the imposition of substantial civil monetary penalties, In re Murlas Commodities, [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,440 at 35,929 (CFTC Apr. 1989). Respondents' violations of the Act involved fraud continuing over a period of at least six months and involving numerous customer orders. We find that the gravity of these violations was sufficient to justify the penalties imposed by the ALJ and that the specific amounts assessed reflect the gravity of each respondent's violations: Rousso $200,000; McGoldrick and Henriksen each $100,000 and Reidy $50,000. Accordingly, we do not disturb the penalties assessed by the ALJ against Rousso, McGoldrick and Reidy.
In light of the foregoing, the ALJ's initial decision is affirmed. The trading prohibitions, registration revocations and civil penalties as modified herein shall become effective 30 days from the date this order is served,(24) except that the civil penalty for Henriksen shall not go into effect pending his compliance with the order to show cause described above and the Commission's further action on such penalty.
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: October 8, 1997
1. Rousso alone accounted for as much as 10 percent of the trading volume in the crude oil pit, earning approximately $1 million in 1988. Reidy's trading accounted for 4 to 5 percent of the volume, and in 1988 both he and McGoldrick earned between $800,000 and $900,000. Henriksen earned about $100,000 trading for his own account, and received a $50,000 salary from Gerald, Inc.
2. RIS was an unregistered floor brokerage firm on NYMEX. Respondent McGoldrick was employed by RIS, and respondent Rousso executed orders for RIS under a contractual agreement. Gerald, Inc. was a NYMEX floor brokerage firm registered with the Commission as a futures commission merchant ("FCM"). Farley and Henriksen executed orders for Gerald customers and also traded for their own accounts.
3. The Futures Trading Practices Act of 1992 ("FTPA"), Pub. L. No. 102-546, 106 Stat. 3590, renumbered this section as 4b(a)(1)(C)(i).
4. The affected respondents opposed on the grounds that (1) the missing records represented an insignificant portion of their records; and (2) NYMEX rules then in effect did not require maintenance of trading cards.
5. Among other things, the Commission revoked Farley's floor broker registration and imposed a four-month trading ban.
6. The first of the two meetings was informal, and no notes were taken by Division staff. At the second meeting, which occurred about a week prior to the hearing, some notes were made by the Division.
7. Under Commission Regulation 10.66(d), 17 C.F.R. § 10.66(d), the ALJ may, at his discretion, order that direct testimony of expert witnesses be made by verified written statement rather than presented orally at the hearing. Any expert witness whose testimony is presented in this manner shall be available for cross-examination and may be examined orally upon re-direct following cross-examination.
8. During the relevant time period, NYMEX members submitted trades for clearing through the use of a pit card system. NYMEX traders created two types of trading records: trading cards, the traders' personal record of the trades they made; and pit cards, which identified the seller, buyer, quantity, contract month, and the price at which the trade was executed. Pit cards were timestamped by NYMEX and fed into a NYMEX data base, from which the exchange created the "street book." The street book was used by the exchange's compliance department to detect illegal trading activity. NYMEX also generated a "time and sales" register, which recorded price changes to the nearest second and provided a history of the price changes occurring in a commodity futures contract during trading hours.
9. Hastings identified the following characteristics in respondents' trades which in her opinion suggested noncompetitive execution: (1) the sequence of prices recorded by the trader was inconsistent with the sequence of prices reflected by time and sales; (2) traders did not record a sequence of trades between themselves in a consistent manner; (3) alterations were made to price, quantity, or opposite broker on a trading card; (4) running totals of a respondent's net position written on a trading card did not reflect a particular trade recorded on that card; (5) trade information was recorded in a different handwriting or with a different instrument; (6) trades were recorded between lines already containing trades; (7) pit cards were submitted out of sequence from the rest of the sales on a trader's cards; and (8) a trade deviated from the trader's normal trading strategy. Hastings at 30-33.
10. In a one-point market, the difference between the bid and ask is the smallest allowable increment of price movement for a contract.
11. Pit cards were thrown into a net in the center of the trading ring by the seller upon completion of each trade. The cards were collected, timestamped, and fed into a NYMEX data base from which the "street book" was created.
12. Q: (by the Division) In the June through November time period, did you ever execute any of your customer orders noncompetitively opposite any of the Respondents in this case?
A: Yes, I did.
Q: With whom?
A: All of them.
Q: How frequently?
A: Not terribly frequently in terms of total numbers of orders. I would say a couple of times a week, maybe.
Q. With each?
A: No, not necessarily all of them every week, but I would say in total it might occur with all of them combined maybe four or five times a week; maybe half a dozen at least.
Q: In that same period, when you were trading for your own account, did you agree to trade noncompetitively with any of the respondents in this case?
A: Yes, I did. . . Neil McGoldrick, David Rousso.
Asked to explain her noncompetitive trading with Henriksen, Farley testified
A: [If we discovered that we had traded with each other and did not each have customer orders] we would do what we call put somebody in the middle...Richard or I would say to the person in question, for example, buy 10 lots for me, sell them to Richard.
Q: . . .was the person in the middle any of the other Respondents?
A: All of the other three.
13. A: On some occasions, I both saw and heard Neil McGoldrick and David Rousso ask Billy Reidy to do noncompetitive trades for them. I stood in the middle between those parties, so --
Q: Did you see Mr. Reidy agree?
14. Rule 10.42(b) requires the Division to produce "all transcripts of testimony, signed statements, and substantially verbatim reports of [witness] interviews."
15. The Division elicited his opinion with respect to trading scenarios that he might consider suspicious:
Q: Are there any. . . circumstances on a trading card of a pit card that would look suspicious
A: If I saw an alteration on a trading card or a pit card, that would possibly be suspicious. Any
change to the original record will elevate my concern. . . . Concentration is a suspicious
event, if I find the concentration between particular members seems to be unusually high.
Q. Would reverse sequencing of trade [sic] look suspicious to you?
Q: Would two persons trading opposite each other at about the same price and about the
same quantity within a very short time look suspicious to you?
16. The judge suspended the registrations of Rousso, McGoldrick, and Henriksen for six months and prohibited them from trading during the same period. Reidy's registration was suspended, and he was prohibited from trading, for two months. Rousso was ordered to pay a $200,000 civil penalty, McGoldrick and Henriksen each were fined $100,000, and Reidy was fined $50,000.
17. Respondent Henriksen challenges Hastings' qualifications to testify as an expert, citing her role as staff investigator. Appeal Brief of Respondent Henriksen at 39-40. It is well settled that government investigators may testify as experts in administrative proceedings, In the Matter of Bear, Stearns & Co., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,994 at 37,662 (CFTC Jan. 25, 1991), and that a witness may offer credible, reliable, and probative expert testimony in a Commission proceeding despite the existence of an ongoing employment relationship with the Division of Enforcement, In the Matter of Buckwalter, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,995 at 37,682 (CFTC Jan 25, 1991); In re Citadel Trading Co., [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,082 at 32,189 (CFTC May 12, 1986). We conclude that there is no merit to Henriksen's challenge.
18. Federal Rule of Evidence 701 permits such testimony by a lay witness provided it is rationally based on the perception of the witness and is helpful to the determination of a fact in issue. Trial courts have broad discretion to determine whether a lay witness is qualified to testify on matters of opinion, U.S. v. Borrelli, 621 F.2d 1095 (10th Cir. 1980), cert. denied, 449 U.S. 956 (1981), and whether to permit the witness to testify as to his conclusions, U.S. v. Wheeler, 444 F.2d 385, 390 (10th Cir. 1971).
19. During cross-examination conducted by Rousso's counsel, Farley stated that she had told the Division during a September 16, 1991 meeting that there were trades she had examined which she could not say were executed noncompetitively. Tr. 193-95. In invoking Brady, respondents do not explain why they failed to explore this testimony.
20. Subsequent to the Initial Decision, respondents jointly filed a related motion to reopen the record to admit the Farley Affidavit, also premised on the Division's alleged failure to disclose required information prior to the hearing. However, respondents have failed to establish that the Farley Affidavit contains material evidence that they could not have readily adduced at the hearing, as required by § 10.107 of the Commission's Rules of Practice. Accordingly, respondents' motion is denied.
21. Hastings observed that trades fitting the pattern occurred on roughly 40 percent of the trading days examined. Hastings at 29. In summarizing her conclusions, she stated that the "number of instances found in the record of this type of trading between these traders forms a pattern of conduct that is unlikely to occur in competitive trading." Id. at 128. Although respondents emphasize the relatively small number of trades relative to their overall trading, we note Morrisey's testimony that, in the context of examining trade practice compliance, even a single trade that fits a noncompetitive pattern is suspicious. Tr. 33.
22. On February 11, 1994, following the issuance of the Initial Decision, respondent Henriksen requested modification of the $100,000 civil penalty imposed against him by the ALJ. In support of his request, Henriksen submitted CFTC Form 177 (Financial Statement of Debtor). On February 15, 1994 the ALJ ruled that the information furnished by Henriksen was unpersuasive, and Henriksen's Motion to Modify was denied.
Respondent Reidy argues that, because he received no personal financial gain from accommodating the other respondents, no penalty should be assessed against him. As discussed above, Reidy's knowing participation in multiple noncompetitive executions of customer orders makes him liable equally with the other respondents.
This complaint alleges conduct in 1989 and was issued in 1991, well before the effective date of the Futures Trading Practices Act of 1992. Accordingly, in assessing civil sanctions, former section 6(d) of the Act governs rather than current section 6(e)(1). Thus the ALJ should have considered not only the gravity of the offenses, but also the net worth of the offenders. In re Gordon, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,326 (CFTC March 6, 1995).
24. A motion to stay the effect of this decision pending reconsideration by the Commission or review by a court must be filed within 15 days of the date this order is served. Compare Commission Rule 10.106, 17 C.F.R. § 10.106 (1996).