UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
__________________________________ : In the Matter of : CFTC Docket No. 93-9 : MICHAEL D. SMITH : OPINION AND ORDER __________________________________:
Respondent Michael D. Smith and the Division of Enforcement ("Division") appeal from an Administrative Law Judge's ("ALJ") decision revoking Smith's registration as a floor broker and imposing a two-year trading prohibition on him. Smith contends that the record shows that neither a registration revocation nor a trading ban is necessary to protect the public interest. The Division contends that the record not only supports the ALJ's revocation of Smith's floor broker registration, but also warrants the imposition of a five-year trading prohibition.
As explained more fully below, based on our independent assessment of the factual record, we revoke Smith's floor broker registration and impose a five-year trading ban.
On May 21, 1993, the Division issued a three-count complaint against respondent Smith. Count I alleged that Smith had violated Section 4b(a)(iv) of the Commodity Exchange Act ("CEA" or "Act"), 7 U.S.C. 6b(a)(iv) (1994), on August 11, 1988 by willfully becoming the buyer on a customer's sell order without the prior consent of the customer. Count II alleged that Smith had violated Commission Rule 1.38(a), 17 C.F.R. 1.38(a) (1996), on August 11, 1988, by executing a Japanese Yen futures contract noncompetitively. As sanctions for the violations alleged in Counts I and II, the complaint sought a cease and desist order, a suspension or revocation of respondent's current registrations, a trading prohibition, and a civil money penalty.
Count III alleged that Smith was statutorily disqualified from registration under Sections 8a(2)(D) and (E) of the Act, 7 U.S.C. 12a(2)(D) and (E) (1994), due to his criminal conviction for violating former Section 4b(D) of the Act, 7 U.S.C. 6b(D) (1988). On March 9, 1993, Smith had pled guilty to the charge of a felony violation of Section 4b(D) of the Act. The court entered a judgment order of conviction in May 1993.
The complaint directed the ALJ to hold a hearing within 30 days to determine whether Smith was subject to the alleged statutory disqualification. If the record established that Smith was subject to the alleged statutory disqualification, the complaint directed the judge to issue an order suspending Smith's registration and requiring Smith to show cause why his registration should not be revoked.
In his answer, Smith generally admitted to the conduct alleged in the complaint but contended that there were circumstances that mitigated the gravity of his wrongdoing. In addition, Smith argued that the proceeding was barred by the doctrine of laches and the Double Jeopardy Clause of the Fifth Amendment to the United States Constitution. Finally, Smith noted that the statutory provision cited in the complaint-- Section 4b(a)(iv) of the Act--was not in effect at the time of his alleged wrongdoing.
In June 1993, the ALJ conducted a hearing regarding the statutory disqualification alleged in Count III. Early in July 1993, the ALJ issued an order that concluded that Smith was subject to a statutory disqualification, suspended Smith's registration for six months, and directed Smith to show cause why his registration should not be revoked. Smith submitted his response to the show cause order in late July 1993, and the Division submitted its reply to Smith's response in September 1993.
As to Counts I and II of the complaint, the Division sought summary disposition on liability in August 1993. Respondent opposed the motion, arguing that a hearing should be conducted on the gravity of his alleged wrongdoing. In September 1993, the ALJ granted the Division's motion but noted that the factual issues Smith had raised in his opposition could be developed at a hearing on sanctions.
On November 18, 1993, the ALJ conducted an oral evidentiary hearing on the sanctions issue. Smith testified on his own behalf and presented testimony from four witnesses. The Division called Smith as an adverse witness and presented testimony from a FBI special agent and a Division investigator.
Smith's testimony provided a brief description of the circumstances that led to his felony conviction. During the period of time in question, Smith worked as a broker in the Japanese Yen pit of the CME. (Tr. at 61-62.) Smith testified that it was typically his practice at the end of each day to go "flat," or even out his purchases and sales of contracts. (Tr. at 52-56.) Smith testified that after the close of trading on August 11, 1988, he was short three contracts in his personal account. (Tr. at 55-56.) Smith further testified that after the close of trading he had two customer orders to sell a total of three contracts. (Tr. at 45-47, 54.) One order was to sell one Japanese Yen contract at the market for a customer of First Options Futures ("First Options"); the second order was to sell two Japanese Yen at 7578 for a customer of Whitehall Futures ("Whitehall"). (Tr. at 63-64, 69-70.) Smith testified that he purchased three contracts opposite his two customer orders through another broker (Tr. at 54-57.) Smith acknowledged that the transaction in question allowed him to "get flat" or close out his open positions for the day. (Tr. at 56.)
Smith stressed that the First Options customer benefitted financially from the improper execution of his order. (Tr. at 66-69.) According to Smith, because the market opened lower the next morning, the customer was better off having taken the position the previous night rather than waiting to sell the contracts. Id. Smith further testified that he did not benefit personally by trading opposite the First Options customer because he lost a few ticks by engaging in the transaction rather than holding on to his short position until the following morning. (Tr. at 67-69.)
Smith also testified about the resolution of both the original criminal proceeding and CME disciplinary actions taken against him. Smith testified that in 1990 a six-month trial on the criminal charges against him resulted in not guilty verdicts on some counts and a hung jury on other counts. (Tr. at 75.) Smith testified that prior to retrial of the remaining counts, he entered a guilty plea to one count on April 28, 1993. (Tr. at 77.) Smith testified that following the resolution of the criminal charges against him, the CME filed disciplinary proceedings against him. (Tr. at 78.) Smith also acknowledged that he had been fined by the CME on two other occasions, including a $25,000 fine in October 1988 for prearranging trades. (Tr. at 81-82.)
As a result of his wrongdoing, Smith claimed he had learned "that all of my actions have consequences and that I have to be responsible for what I do and how I handle myself every day, especially on an exchange that's made up of rules and regulations set down by the Exchange and the government." (Tr. at 79.) Smith explained, "Everyday I was there, I was conscious of what had occurred and how I should change my behavior to conduct myself within the rules of the Exchange." Id. Smith vowed that if given the opportunity to trade again, he would not engage in the type of conduct that resulted in his conviction. Id.
Smith also emphasized his lack of wrongdoing since his criminal conviction. Smith testified that since 1990 he had stopped filling orders on behalf of customers and only traded as a local for his own account until the ALJ's July 12, 1993 interim order in this proceeding suspending his registration for six months. (Tr. at 70-71.) According to Smith, during the period of time he was still filling customer orders in 1989 and thereafter when he was trading for his own account, he was not investigated or charged with violating any trading rules or statutes. (Tr. at 71.) Finally Smith testified that if he was permitted to continue trading, he would trade through a clearing firm that had agreed to supervise his trading. (Tr. at 73-74.)
Smith also offered the testimony of three personal friends as character witnesses. The witnesses testified that Smith does not present a risk to market integrity or the trading public and that Smith would not repeat his earlier misconduct. (Tr. at 147, 192, 198.) Two of the witnesses expressed the view that they considered Smith to be honest and that their opinions of him had not changed as a result of his criminal conviction. (Tr. at 191, 195-197.) George Klahn, a vice president of Hammerstone and Company, a clearing firm for local traders at the CME, testified that Smith has been a good customer, that he had received no complaints regarding Smith's trading, and that he had experienced no problems with Smith's account. (Tr. at 147.) Vince Rossi, an investment executive with Kidder Peabody who had traded with Smith, expressed his opinion that Smith's criminal conviction had the effect of heightening Smith's sensitivity to his fiduciary responsibilities and the need to abide by the rules. (Tr. at 194-195, 197-198.)
For its part, the Division offered the testimony of FBI special agent Dietrich Volk. Volk was assigned to undercover duties at the CME in March 1987, and he came to know Smith when he started working in the Japanese Yen pit in early 1988. (Tr. at 85-86.) Volk testified that shortly after the closing bell on August 11, 1988, he witnessed Smith hand customer orders to sell three September Japanese Yen contracts to another broker and instruct the broker to sell them to him. (Tr. at 89-90.) Volk stated that on three other occasions in 1988 he engaged in similar trades involving customer orders with Smith after the close of trading. (Tr. at 92-97.) Volk also recalled conversations with other traders who told him they had engaged in illegal transactions with Smith. (Tr. at 98.) In response to a question from the ALJ, Volk testified that he had witnessed and participated in similar transactions with other traders in that pit and that Smith was not unique in the way he did business as compared to the other members of the pit. (Tr. at 91-92, 131- 132.)
The parties submitted post-hearing briefs, and on June 8, 1994 the ALJ issued his initial decision. In re Smith, [1992- 1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) 26,099 (ALJ June 8, 1994). At the outset, the ALJ found that there was a clear nexus between Smith's wrongdoing and the integrity of the markets regulated by the Commission because respondent's violations "occurred on the trading floor of the CME." Id. at 41,639.
In reviewing the seriousness of Smith's wrongdoing, the ALJ noted that there were both mitigating and aggravating circumstances. As to mitigation, the ALJ found there was no evidence that Smith had executed the trade with the intent of harming the First Options customer. Id. In this regard, the ALJ credited Smith's testimony that he had bought the contract in question to close out a short position and had actually lost money on the transaction, whereas the First Options customer actually benefitted by not having to wait for an execution at the opening on the following day. Id. In addition, the ALJ noted FBI agent Volk's testimony that Smith's wrongdoing was not "totally out of line" with the other conduct in the pit at the time. Id. at 41,640.
As to aggravating circumstances, the ALJ noted that Smith's violation of Commission Rule 1.38 aggravated the seriousness of his felony violation. Id. In addition, the ALJ credited FBI agent Volk's testimony that Smith had engaged in prearranged trading on other occasions in 1988 and that other traders had told him that they had participated in illegal transactions with Smith. On this basis, the ALJ found that respondent "often engaged in prearranged trading, at least during the period Agent Volk was conducting his investigation." Id. The judge concluded that his evidence "increases the weight ordinarily accorded the presumption that respondent will remain a threat to market integrity for at least five years." Id.
Balancing the evidence of mitigation against the evidence of aggravation, the ALJ concluded that the evidence of mitigation predominated. In this regard, the judge emphasized Volk's testimony about other conduct in the pit during the time in question and concluded that "[t]here is nothing to be gained by singling out this respondent for harsher sanctions." Id.
On the issue of rehabilitation, the ALJ credited Smith's assertion that as a result of his experience he is conscious of the need to abide by the rules. Id. In addition, the judge emphasized the absence of any evidence of additional trading violations by Smith in the period since 1988. Id. at 41,641. While the ALJ found the testimony of Smith's character witnesses merited only limited weight, he concluded that on the whole, Smith "ha[d] taken steps toward full rehabilitation." Id.
Finally, with respect to Smith's role in the market place, the ALJ noted that Smith had stopped filling customer orders in early 1990. Id. The ALJ concluded that Smith would not pose a threat to the integrity of the market by "bucketing" customer orders because Smith had asserted that he wishes to continue trading for his own account only. Id.
In light of his findings on nexus, mitigation, rehabilitation, and role in the market place, the ALJ concluded that Smith had rebutted the statutory presumption that he should be denied access to all regulated markets for a period of five years. Id. Nonetheless, he concluded that given the nature of respondent's violations, a trading ban of some length was necessary to protect the public interest. Id. As a result, he prohibited Smith from trading on Commission-regulated markets for two years. Id. at 41,641-42.
As to the Division's request that Smith's floor broker registration be revoked, the ALJ noted that Smith did not intend to fill customer orders in the future and had offered no evidence to rebut the presumption that he was unfit for continued registration. Id. at 41,641. In these circumstances, the ALJ ordered that Smith's registration be revoked.
Both parties appealed the ALJ's initial decision.
On appeal, both parties challenge the ALJ's trading ban analysis, focusing on alleged errors in the ALJ's assessment of the evidence of mitigation, rehabilitation, and role in the market place. In addition, Smith argues that the ALJ incorrectly assessed the evidence when he revoked Smith's registration.
On the trading ban issue, Smith argues that the ALJ's mitigation finding is supported by evidence that the transaction on which his conviction was based involved only one instance and did not result in any harm to the customer. Smith also argues that the Division's aggravation evidence should be discounted because it involved trades for which he was not convicted and there was no showing of intent to harm any of the customers. Respondent's Appeal Brief at 8-10.
As to rehabilitation, Smith emphasizes the absence of any further misconduct since 1988. Respondent's Appeal Brief at 7. In addition, Smith contends that his testimony as to his remorse and acceptance of responsibility for his wrongdoing shows he is unlikely to engage in further misconduct. He also argues that the ALJ failed to give sufficient weight to the testimony of his character witnesses. Respondent's Appeal Brief at 10-11. As to his role in the marketplace, Smith emphasized that he no longer intends to fill customer orders in the future and only desires to trade for his own account. Smith also argues that the ALJ failed to consider an offer by Spike Trading Company to supervise his trading. Respondent's Appeal Brief at 13-14.
The Division argues that the ALJ failed to assess correctly the gravity of Smith's misconduct. It argues that the ALJ erred in accepting Smith's claim that his misconduct was mitigated because the customer benefitted from the illegal trade and Smith, correspondingly, lost money. The Division argues that the fact that the market moved in such a manner was simply fortuitous and that, as a policy matter, unforeseen events (such as the price at which the market opens) should not form the basis of a mitigation finding. In addition, the Division argues that the ALJ failed to give adequate weight to evidence indicating that the seriousness of Smith's wrongdoing was aggravated. Division's Appeal Brief at 8-10.
With respect to the rehabilitation evidence, the Division argues that the lack of wrongdoing since the time of the misconduct underlying Smith's disqualification does not show rehabilitation. It relies on Commission precedent holding that rehabilitation will not be inferred from the mere passage of time. Division's Appeal Brief at 15. Finally, the Division argues that Smith's offer to limit his trading to his own account is not dispositive, citing Commission precedent that a reduced role in the market cannot serve as a substitute for persuasive evidence of mitigation and rehabilitation. Division's Appeal Brief at 18.
Smith also challenges the ALJ's revocation of his floor broker registration. He argues that the ALJ placed undue reliance on Smith's statement that he did not intend to fill customer orders in the future and did not fully consider evidence indicating that Smith's continued registration will pose no substantial risk to the public. Respondent's Appeal Brief at 15- 16. The Division argues that the ALJ's revocation order is supported by the record and consistent with Commission precedent. Division's Answering Brief at 9-12.
We consider first the parties' arguments relating to the two-year trading ban imposed by the ALJ.
Section 9(b) of the Act directs us to impose a trading prohibition of at least five years on any person convicted of a felony under the Act. In In re LaCrosse, [1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) 25,840 at 40,755 (CFTC Aug. 13, 1993), we stated that this statutory directive rests on a common sense judgment that, once an individual has undertaken serious wrongdoing, there is a substantial risk that he will undertake similar wrongdoing in the future. We held that, once the Division has demonstrated the appropriate type of felony violation, a presumption arises that the respondent will pose a substantial risk to the markets regulated by the Commission for at least five years. Under the terms of the statute, this presumption arises without regard to the nature or gravity of respondent's felony violation.
In LaCrosse, we concluded that the statutory presumption was not conclusive. An exception from the requirement of a five-year trading prohibition is permitted if the Commission determines that imposition of a trading prohibition "is not required to protect the public interest." Id., quoting Section 9(b) of the Act. As a result, we held that a respondent should be given an opportunity to rebut the presumption by showing that the weight of the evidence indicates that his continued access to the markets will "pose no substantial risk to their integrity." Id.
We begin by assessing the mitigation evidence offered by respondent. Smith emphasizes that he was convicted of a single felony arising out of a transaction in which the customer benefitted at Smith's expense. In the circumstances of this case, however, the benefit to Smith's customer was completely fortuitous. There is no question that Smith acted intentionally to pursue his own interest--obtaining a flat position--rather than pursuing the legitimate interests of his customer. Despite the market's fortuitous movement in the customer's favor, the fact remains that this breach of duty exposed Smith's customer to significant financial risks.
In addition, the fact that other CME members also may have engaged in illegal practices neither explains nor mitigates Smith's misconduct. To the contrary, if an exchange proves unable or unwilling to enforce compliance with applicable standards of conduct, there is a greater need for the Commission to impose sufficiently significant sanctions to deter others from similar behavior and to protect the public interest. Nor do we believe that the fact that others at the CME may also have disregarded the law in any way lessens Smith's personal culpability.
We also consider aggravation evidence offered by the Division. The wrongdoing underlying Smith's felony conviction is aggravated by evidence of a pattern of similar misconduct. The Division offered FBI agent Volk's unrebutted testimony that Smith engaged in similar misconduct on at least three other occasions. Such a pattern of misconduct establishes a strong likelihood that wrongdoing will be repeated. Cf. Precious Metals Assoc. v. CFTC, 620 F.2d 900, 912 (1st Cir. 1980) (holding that a proclivity to violate the law may be inferred from persistent attempts to interfere with legislatively protected rights).
The record also establishes that Smith was disciplined by the CME on two occasions prior to the misconduct underlying his felony conviction. Evidence of such prior wrongdoing is clearly relevant in assessing the threat a respondent will pose to market integrity in that it further indicates a pattern of respondent's failure to comply with significant regulatory requirements.
Based on the foregoing analysis, we conclude that Smith has failed to mitigate the seriousness of his wrongdoing and that the presumption that arises as a result of his felony conviction is strengthened in this case by a pattern of evidence of non- compliance with legal requirements. Accordingly, we turn to the issue of "the changed direction of his activities," which is the focus of a rehabilitation analysis. Compare In re Horn, [1990- 1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) 24,836 at 36,940 (CFTC Apr. 18, 1990); In re Tipton, [1977-1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) 20,673 at 22,750 n.9 (CFTC Sept. 22, 1978); In re Akar, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) 22,927 at 31,709-10 (CFTC Feb. 24, 1986).
Smith's evidence regarding rehabilitation does not establish the type of significant change that would warrant an inference that he poses no substantial risk to market integrity. As to rehabilitation, we agree that evidence of Smith's acceptance of responsibility for his wrongdoing is some indication of an appropriate change in attitude. In the circumstances presented, however, Smith's acceptance of responsibility amounts to only a limited first step on the path of rehabilitation.
Moreover, Smith produced no evidence that the wrongful nature of his conduct was unclear at the time of his violation. In similar circumstances, we have found that expressions of contrition following detection merit only limited weight.
Similarly, we give limited weight to the opinions expressed by Smith's character witnesses. Smith did not attempt to qualify any of his witnesses as experts on the issue of rehabilitation. Compare Walter, 24,215 at 35,015 (probation officer, who worked closely with respondent for a significant period following his conviction, had the type of experience and expertise that buttressed the reliability of his opinion on the likelihood of future violations). Our precedent recognizes the limited value of opinions from friends and business acquaintances about the likelihood a respondent will repeat his misconduct. See, e.g., In re LeClaire, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) 26,282 at 42,428 (CFTC Dec. 12, 1994)(noting that almost every respondent can produce evidence such as testimony from a friend or colleague attesting to the respondent's good character and the witness' belief that he will not repeat his violative conduct).
Smith stresses his record of trading without any wrongdoing since the time of his misconduct. That Smith has traded without incident adds some credence to his claim that he has changed the direction of his conduct. We have noted in the past, however, that the weight accorded such evidence must be limited when respondent is the subject of an outstanding administrative complaint during the period at issue. See In re Silverman, [1977-1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) 20,410 at 21,643 (CFTC Mar. 14, 1977), affirmed sub nom. Silverman v. CFTC, 562 F.2d 432 (7th Cir. 1977).
Finally, as to his proposed role in the market, Smith wants to change his role in the market from being a floor broker to being a floor trader. The ALJ expressed the view that such a change of status would eliminate the threat that Smith would repeat his misconduct. Smith, 26,099 at 41,641. Even as a floor trader, however, Smith would remain in a position to engage in similar misconduct with floor brokers who need cooperation to deceive their customers.
In light of our evaluation of the record as a whole, we conclude that respondent's limited evidence of mitigation and rehabilitation does not establish that Smith's continued access to the markets we regulate will pose no substantial risk to their integrity. Accordingly, we determine that Smith should be prohibited from trading on markets regulated by the Commission for a period of five years.
We turn next to Smith's argument that his floor broker registration should not have been revoked. Proof of Smith's statutory disqualification under Sections 8a(2)(D) and (E) of the Act raises a presumption that he is unfit to act as a Commission registrant. Horn, 24,836 at 36,939. This presumption rests on the commonsense inference that, once an individual has undertaken serious wrongdoing, there is a substantial risk he will undertake similar wrongdoing in the future. Akar, 22,927 at 31,708. Thus, Smith may only retain his registration by making a clear and convincing showing that his continued registration would not pose a substantial risk to the public. See Commission Rule 3.60(e)(1), 17 C.F.R. 3.60(e)(1)(1996); Horn, 24,836 at 36,939 n.15.
As the complaint alleged, Smith pled guilty to one felony count of violating former Section 4b(D) of the Act. The ALJ correctly concluded that Smith's felony conviction constituted a statutory disqualification from registration pursuant to Sections 8a(2)(D) and (E) of the Act, and Smith does not dispute that his felony violation consequently raised a presumption that he is disqualified from registration.
Smith argues that his evidence pertaining to the trading ban issue also shows that there is no need to revoke his registration. Having already concluded that Smith has failed to adduce evidence sufficient to support a finding of mitigation or rehabilitation, we reject this contention too. See supra at 15- 20.
Finally, Smith argues that, if the Commission should conclude that some restriction is necessary, his floor broker registration should be converted to a floor trader registration. We recently held, however, that the standard applicable to registration as a floor trader is the same as the standard applicable to registration as a floor broker. In re Castellano, CFTC Docket No. SD 94-11 (CFTC Dec. 10, 1996).
In light of our evaluation of the record as a whole, we conclude that Smith has failed to make a clear and convincing showing that his continued registration would pose no substantial risk to the public. Accordingly, based on the evidence that Smith is subject to statutory disqualification from registration, we affirm the ALJ's revocation of his registration as a floor broker.
In light of Section 9(b)'s mandate and our assessment of the record as a whole, we conclude that respondent should be prohibited from trading on the markets regulated by the Commission for a period of five years. We also affirm the ALJ's revocation of Smith's floor broker registration. The five-year trading prohibition, and the cease and desist order and registration revocation imposed in the ALJ's initial decision, shall become effective 30 days from the date this order is served.
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: March 11, 1997