UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
In the Matter of
CFTC Docket No. 93-4
OPINION and ORDER
Respondents appeal from the initial decision finding them liable for a series of noncompetitive options transactions in the Coffee, Sugar, and Cocoa Exchangeís ("CSCE") sugar pit. Respondents argue that the Administrative Law Judge ("ALJ") denied them a fair hearing, entered liability findings that were unsupported by the weight of the evidence, and imposed unduly severe sanctions. In response, the Division of Enforcement ("Division") urges the Commission to reverse the ALJís determination that respondent Zoltan Guttman was not liable as a controlling person and to uphold the initial decision in all other respects. For the reasons that follow, the initial decision is affirmed in part and reversed in part.
On February 17, 1993, the Commission issued a seven-count complaint charging Gary Glass, Zoltan Guttman, Harold Magid, and Gerald, Inc., with multiple violations of the Commodity Exchange Act, 7 U.S.C. ßß 1-28 (1988) ("Act"), and the Commissionís regulations. The allegations arose from respondentsí activities relating to twelve transactions conducted in the CSCE sugar pit from March 31 through October 2, 1989. The complaint alleged violations of the Actís trade practice, recordkeeping, reporting and financial reporting requirements.
The alleged trade practice violations relate to a trading account opened at Gerald, a registered futures commission merchant ("FCM"), in which Magid and Guttman each owned fifty percent ("Magid/Guttman account"). The complaint also alleged that Magid and Guttman were the sole shareholders of Harley Futures, Inc. ("HF"), a New York corporation registered as an introducing broker, for which Guttman served as president and Magid as secretary. The complaint further alleged that Magid and Glass knowingly engaged in a series of pre-arranged fictitious wash trades at month-end to reduce temporarily the substantial net equity deficits in the Magid/Guttman account. The complaint identified six sets of trade sequences which Magid and Glass entered into and offset on the following trading day. Guttman allegedly was aware of the need to reduce the deficits in the Magid/Guttman account and directed Magid to enter into the unlawful trades with Glass.
The complaint alleged that Magid and Glass entered into wash, fictitious and accommodation trades in violation of Section 4c(a)(A) of the Act; caused non-bona fide prices to be reported in violation of Section 4c(a)(B) of the Act; and violated Commission Rule 1.38 by engaging in non-competitive trading. Pursuant to Section 13(b) of the Act, the complaint charged that Guttman was liable as a controlling person of Magid for Magidís violations. The complaint also alleged that Guttman was liable for Magidís violations pursuant to Section 2(a)(1)(A) of the Act and Commission Rule†1.2, because Magid was acting as Guttmanís agent in executing the unlawful transactions.
The complaint also alleged that Glass had failed to retain and produce his records reflecting the transactions at issue. Accordingly, the complaint charged that Glass had violated Section 4g(1) of the Act and Commission Rules 1.31(a) and 1.35(a).
The complaint also charged Gerald with failure to satisfy the Commissionís reporting and financial requirements in connection with such trading. Specifically, Gerald allegedly represented to Guttman that it would not collect initial and maintenance margin for commodity interests in personal accounts that Gerald carried for Guttman on 120 of the 130 trading days from March 30, 1989 through October 2, 1989. The complaint also alleged that Gerald falsely reported its adjusted net capital and excess net capital on CFTC Form 1-FR from May 31 to August 31, 1989. Finally, the complaint charged that Gerald failed to maintain its net capital as required by the Commission on June 30 and July 31, 1989. Accordingly, the complaint charged Gerald with failure to collect initial and maintenance margin in violation of Commission Rule 1.56(b)(3), filing false reports with the Commission in violation of Section 4f(1) of the Act and Commission Rule 1.10(d), and failure to maintain adequate net capital and operating while undercapitalized in violation of Section 4f(2) of the Act and Commission Rules 1.17(a) and 1.17(d).
Simultaneously with its issuance of the complaint, the Commission issued an opinion and order accepting Geraldís offer of settlement. In re Gerald, CFTC Docket No.†93-4, 1993 WL 47706 (CFTC Feb. 17, 1993), In re Gerald, CFTC Docket No.†93-4, 1993 WL†47707 (CFTC Feb.†17, 1993). On April 18, 1995, the Commission accepted Magidís offer of settlement, finding that Magid had committed the violations charged in the complaint. In re Magid, CFTC Docket No.†93-4, 1995 WL 231235 (CFTC Apr. 18, 1995).
The parties engaged in discovery and filed prehearing memoranda. The ALJís prehearing order, issued on May 10, 1993, required the parties to identify in their pre-hearing memoranda the witnesses who were expected to testify and to provide the direct testimony of expert witnesses in writing attached to the prehearing memoranda. On October 13, 1995, less than two weeks before the hearing was scheduled to begin, Guttman filed a request to supplement his witness list with respondent Glass and a polygraph expert who had examined Guttman in July 1992. The Division opposed Guttmanís request. After argument by both parties, the ALJ denied Guttmanís request with respect to the polygraph expert but permitted Glass to serve as Guttmanís witness in view of his status as a respondent in this case.
The hearing took place in New York on October 24-27, 1995. The Division presented Magid as its chief witness. In addition, the Division presented documentary evidence and the testimony of expert, investigatory, and other fact witnesses, including Guttman. Glass participated in the hearing on a pro se basis and testified on his own and Guttmanís behalf. Guttman testified on his own behalf and, in addition to Glass, presented the testimony of several fact and character witnesses.
Vincent White, the Divisionís expert, testified that from March 30 to September 28, 1989, the Magid/Guttman account at Gerald had negative equity at month-end (except for the end of June), which ranged from approximately $250,000 to $5.4 million. (White Declaration at 5.) White stated that Magid sold Glass a total of 4,430 calls and a total of 4,430 puts on the last trading days of March, April, May, July, August and September 1989. (Id. at 3-14, Appendix A.) With one exception, Magid repurchased the same instruments from Glass on the first trading days of the following months. (White Declaration at 3-14, Appendix A.) White calculated that as a result of these sales each month, the Magid/Guttman account was credited between $991,200 and $4,402,944, and Glassís account was debited correspondingly. (White Declaration at 3.) White testified that after these positions were offset, the Magid/Guttman account was debited for virtually the same amount credited the preceding day and Glassís account was credited correspondingly. (Id. at 3-4.) White noted that the offsetting transactions in each of the six trade sequences resulted in no change in market position and virtually no change in financial position in either the Magid/Guttman or Glass accounts. (Id.† at†4.)
In analyzing the six trade sequences, White emphasized that: (1) not one of the 4,430 calls and 4,430 puts was executed or offset opposite any other person; (2) each transaction was allocated to accounts owned or controlled by Magid and Guttman or by Glass; (3) large single transactions were executed without intervention by other traders or brokers; (4) each transaction was offset at the same price or at a price equal to the minimum fluctuation permitted in Sugar #11 options; (5) there was little or no activity by competing floor brokers and floor traders; and (6) whenever Glass bought options from Magid, Glassís account had insufficient funds or equity to satisfy the large premiums which were debited. (Id. at 4-5, 14.)
Based on these facts, White inferred that Magid understood that Glass would satisfy his execution and quantity requirements. (Id. at†14.) He also inferred from Glassís willingness to participate repeatedly in the sizable trades that Glass knowingly participated in the trading pattern. (Id.) White stated that this pattern of trading was unlikely to occur in open and competitive trading and concluded that Magid and Glass structured the Appendix A trades to negate price competition and market risk. (Id. at 14-15.)
Testimony of Fact Witnesses
Guttmanís Business Relationship with Gerald
In 1986, Julian Raber, Geraldís chief operating officer, approached Guttman to manage a group of local traders for Gerald. (Tr. at 469-471, 784-786.) Guttman entered into a written agreement with Gerald, which entitled Guttman to revenue from the trading and made him personally responsible for half the losses generated by the traders he introduced to Gerald. (Tr. at†784-786.) Guttman began introducing his floor trader friends to Gerald as their clearing firm. (Id.)
The Guttman/Magid Partnership
In 1986 Magid approached Guttman, who agreed to sponsor him as a floor trader clearing trades through Gerald. (Tr. at 787.) After having a chance to observe Magid trading options, Guttman became "awed" by Magidís knowledge and ability. (Tr. at 787-788.) In June 1987, Guttman and Magid began an informal partnership to "fuse" Magidís expertise as an options trader with the revenue stream from Guttmanís brokerage arrangement with Gerald. (Tr. at 788-789, 790-791.)
Guttman and Magid each contributed $150,000 to capitalize their first joint account with Gerald with the understanding that Magid would trade options for their mutual benefit. (Tr.†at†33.) In addition, Guttman gave Magid the use of one of his NYMEX seats at a price below market to facilitate Magidís trading. (Tr.†at†838.) Guttman and Magid agreed to share equally in the trading profits and the proceeds from Guttmanís brokerage revenue. (Tr. at 30-35, 54-55.) Later, when Guttman and Magid formed HF as equal shareholders, Guttman assigned the revenue stream from his contract with Gerald to HF in order to fund the salaries and other expenses of the trading operation. (Tr. at 54-55, 792-794.) HFís offices, located in Geraldís suite in the World Trade Center, contained workstations for HF employees and a private office for Magid and Guttman. (Tr. at 36-37.)
Magid was responsible for the day-to-day management and trading of the joint accounts. (Tr.†at 171-172.) As the trading operation expanded, he and Guttman jointly opened additional accounts and together hired additional traders to trade their accounts. (Tr.†at†46-49, 355-377, 408-411, 799-800.) Magid supervised the traders and reviewed their positions daily. (Tr. at 172, 355, 385-386, 801-802.) Magid testified that he and Guttman shared their views of the market and trading strategies for particular positions. (Tr. at 172-178, 185.) Magid also testified that they received copies of the daily confirmation statements and equity runs for the joint accounts, he regularly reviewed with Guttman their exposure in the joint accounts, and Guttman reviewed the statements regarding the general size of positions. (Tr. at†172, 177.)
Guttman testified that he did not trade options and had only a general understanding of them. Occasionally, Guttman traded futures for the Magid/Guttman account. (Tr. at 175-178, 182-183, 821-822.)
Guttman managed HFís financial affairs. (Tr. at 713-714.) He was responsible for maintaining the books and records, filing regulatory forms, obtaining financing, furnishing information to the accountant for preparation of income tax returns, and general financial reporting. (Tr. at 55-57, 713-714, 805-807, 819.) Guttman continued fulfilling these responsibilities after he was elected chairman of NYMEX in August 1988. (Tr. at 819.)
The Need for Financing
In 1988, Magid wanted to increase the long options positions in the joint accounts and needed additional financing to support the trading. (Tr. at 547-548, 593, 805.) In a meeting with Raber and the president of Geraldís holding company, Graham Perske, Guttman and Magid presented a business plan offering Gerald an opportunity to make money by charging interest on the financing provided. (Tr. at†227, 550, 547-549.) Raber claimed that Magid assured them that the options positions were secure and that Guttman expressed his confidence in Magidís trading strategies. (Tr. at 593-595, 615.) Accordingly, Gerald agreed to lend $3 million to Guttman and Magid for up to 80 percent of the long option value traded in the joint accounts. (Tr. at 547-548.) The initial financing was adequate for only one or two months; Geraldís exposure soon increased to $5 million. (Tr. at 550, 803-804, 843-844.)
In response to pressure by Gerald in the latter part of 1988, Guttman and Magid sought outside financing for the joint accounts. (Tr. at 803-806, 843-844.) Using Guttmanís contacts at NYMEX, they established a $2 million line of credit for the Magid/Guttman account through Brown Brothers Harriman ("BBH"). (Tr.†at†58-60, 806-807.) Both Guttman and Magid signed the BBH loan agreement; Raber signed on behalf of Gerald. (GX606.) The BBH line of credit solved the financing needs for an additional two to three months. (Tr.†at†808.) By late 1988 or early 1989, however, the joint accounts needed additional funds. (Tr. at 809.)
Discussions Prior To The Unlawful Trades
Gerald became concerned as the debit equity in the Magid/Guttman account continued to grow. (Tr. at†62-65.) In a brief meeting with Guttman and Magid in February or March 1989, Magid testified that Raber told them of tremendous pressure from Geraldís headquarters to avoid financing at month-end. (Tr. at 62-65.) Raber informed Magid and Guttman that "they had to produce revenue for the accounts, either by liquidating the account or by giving [him] a check." (Tr. at 554, 810.) After a short discussion, they concluded that obtaining additional outside financing was not realistic. (Tr.†at†812.) At Magidís suggestion, they decided to investigate the use of financing trades utilizing box spreads. (Tr. at 554, 811.) Magid stated that he told Guttman and Raber that these trades would generate large credit balances to offset debit equity balances resulting from other existing long-term option positions. (Tr. at 65-66.) All three of them understood that the transactions were to be entered into at month-end for the purpose of short-term financing and would be reversed within a few days. (Tr.†at†65-66, 556-557, 584.)
Magid explained that implementation of this strategy would not be easy because CSCE is not a financial market. (Tr.†at†66-67.) Magid mentioned the names of several possible counterparties, including Glass. (Tr. at 67, 579-580, 813.) Magid suggested that they contact Glass and claimed that Guttman agreed to make the initial contact to determine whether Glass was willing to assist them. (Tr. at 67-68.) Both Guttman and Glass denied that Guttman made the initial contact. (Tr. at 752, 813.)
Magid testified that Guttman conferred with Glass shortly after this meeting and reported to Magid that Glass was willing to provide several million dollars in financing as long as the trades were unwound within a couple of days of being executed; Guttman asked Glass to work out the details with Magid. (Tr. at 69-70.) Guttman and Glass, however, denied having spoken to each other about these transactions. (Tr. at 752, 813.)
Magid also stated that he talked with Glass a few days later to confirm the amount of financing required, the short-term nature of the trades, and Glassís compensation. (Tr.†at†70-71.) Magid testified that Glass stated that he did not need a profit but wanted to recoup his costs. (Tr. at 71.) To reduce the commission charge, the largest component of Glassís cost, Magid testified that he and Glass decided to do strangles instead of boxes because they required only half as many contracts. (Tr. at 72.) Glass maintained, however, that only five minutes before they executed the first Appendix A trade, Magid insisted on executing strangles. (Tr. at 746-747.)
Magid claimed that he had informed Guttman about his meeting with Glass and described the potential financial loss to the Magid/Guttman account if Glass did not liquidate the trade the following day or if there were a substantial move in the market. (Tr. at 73-74.) Magid asserted, however, that Guttman assured him that Glass would honor his side of the agreement and stated that it was more important to reduce costs by half. (Tr. at 74.) Guttman testified that he did not know in advance that Glass was the counterparty or that transactions were strangles instead of boxes. (Tr. at 816.)
The Unlawful Transactions
Magid described the process whereby the Appendix A trades were initiated. Magid stated that, on the morning of the last trading day of each month, either a Gerald representative or HFís office manager would notify Magid of the amount of funds needed to be raised.(Tr. at 77-78.) Magid testified that he calculated the number of contracts required for a particular trade and summoned Glass, who usually stood in the coffee/cocoa option ring, to the sugar option ring. (Tr. at 78-79.) Magid stated that he and Glass discussed a general figure as to how much financing was needed and then made a market on a particular strangle, recorded it as a spread trade on trading cards, and submitted it for clearing. (Tr. at 79-80.) Magid testified that he then contacted Raber or Guttman to confirm that the initiating trade had been executed. (Tr. at 80.) Magid testified that, with Guttmanís knowledge, he instructed HF computer personnel not to reflect the Appendix A trades on the internally generated reports in order not to confuse existing positions with the trades that he knew would be unwound the next day. (Tr. at 83-84.) Guttman testified that he had no advance knowledge of individual transactions, but that Magid did report to him that he had "compl[ied] with Julie Raberís request." (Tr. at 814-817.)
Magid stated that on the first trading day of the following month he and Glass offset the initial transaction in two trades: first, they executed one set of contracts at the same price as the initiating transaction, and then they executed a second group at a one point differential to compensate Glass for his costs. (Tr.†at†81-82.) Magid testified that he notified either Raber or Guttman after reversing the trades. (Tr.†at†83.) Magid testified that he stopped doing the short-term financing trades as of October 2, 1989, because he and Guttman obtained fixed rate, longer term financing through Guttmanís contact at Phillip Brothers. (Tr. at 139-140.)
Glass admitted that he had executed the trades with Magid that are set forth in Appendix†A, but claimed that he did so by open outcry in the pit and reported and posted the trades in accordance with CSCE rules. (Tr. at 745-749.) Glass also contended that at the time of the first transaction he and Magid did not speak about engaging in similar transactions in the future. Rather, the subsequent transactions were discussed on the day each one was executed. (Tr. at 750-751.)
Glass also admitted to a number of record-keeping errors surrounding these trades. (Tr. at 760-761, 763-768.) Glass acknowledged that he had not produced his trading cards to the Division. (Tr. at 770.) He explained that his clerk kept his records on the exchange floor and the exchange moved the records one night in November 1990 without notice. (Tr.†at†776.) Glass claimed that he was unable to retrieve the trading cards. (Tr. at 776.)
Guttman testified that his responsibilities as NYMEX chairman kept him very busy throughout 1989. (Tr.†at†817-819.) Guttman admitted, however, that he continued to carry out his administrative and financial responsibilities for HF. (Tr.†at†819.) Guttman also acknowledged that during this period he found time to trade his personal account and that he transferred funds at Raberís request from the Magid/Guttman account to his personal trading account on four to five occasions to cover personal trading losses. (Tr.†at†826-827, 844-845.)
Guttman claimed that pressure by Raber to reduce the debit equity caused tension between him and Magid and thus he and Magid agreed orally in April 1989 to sever their relationship in the joint accounts. However, Guttman testified that he and Magid had agreed that Guttman would withdraw his partnership capital accumulated "over a period of time" because Magid was unable to liquidate the positions and CFTC regulations did not permit him to transfer his ownership interest in the Magid/Guttman account or other joint accounts to Magid while the accounts had open positions. (Tr. at 825-826, 828.) Raber testified that he was not aware of any change in the relationship between Guttman and Magid during approximately mid-1989. (Tr. at 557.)
Severe margin problems in mid-1990 forced Guttman and Magid to liquidate the joint accounts and disband their business operations. (Tr. at 183-187, 577, 827, 829-831.) The liquidation of the accounts was completed in August 1990. (Tr. at†184, 577.)
The ALJ issued an initial decision on September 11, 1996. The ALJ found Magidís testimony credible and credited some of Raberís testimony as well. In re Glass, ∂†26,787 at†44,233-44,236. The ALJ found Glassís testimony not credible. Id. at†44, 234. Although the ALJ did not make direct findings regarding Guttmanís credibility, it appears that the ALJ did not find Guttman credible. Id. at†44,232-44,236. After reviewing the testimony and documentary evidence, the ALJ described the trade sequences in detail and made extensive fact findings upon which he premised his conclusions concerning the liability of Guttman and Glass. Id.
1. Glassís Illegal Trades and Failure to Produce Records
The ALJ determined that Glass agreed to trade with Magid on the CSCE as long as they reversed each trade on the next business day and that Glass was compensated for his costs. Id. at†44,234. The ALJ found that Magid calculated the amount of funds needed temporarily to reduce the debit equity in the Magid/Guttman account and then summoned Glass, who ordinarily stood in the cocoa and coffee rings, to the sugar option ring. Id. at†44,234-44,236. The ALJ found that Magid and Glass agreed beforehand as to the number of options to be traded, the months, the premiums, and the spread in the strike prices. Id. at†44,234. In each transaction, the ALJ noted, "there was little or no open interest by competing floor traders or brokers." Glass, ∂ 26,787 at 44,234 (citing DX 592). The ALJ concluded that the funds credited to the Magid/Guttman accounts were "utterly artificial." Id. at 44,236-44,237. When the trades were reversed the following business day Glass received as much as $5,000 "in addition to currying favor with Magid and Guttman, big players in futures and options." Id. at 44,237.
The ALJ concluded that the trades executed by Magid and Glass were fictitious wash sales because the trading techniques that they employed gave the appearance of open market transactions when in fact the risk had been negated and that they knowingly intended to avoid a bona fide market position. Consequently, the ALJ found Glass reported non-bona fide prices in violation of Section 4c(a)(B) of the Act. Id. at 44,236-44,237. The ALJ also found that, by prearranging the trades, Magid and Glass engaged in noncompetitive trades in violation of Rule 1.38 and that, by assisting Magid in unlawful trades, Glass engaged in accommodation trading in violation of Section 4c(a)(A) of the Act. Id. at†44,237. Finally, the ALJ found that Glass failed to comply with his obligation to keep copies of his trading cards for five years and to produce them when requested by the Commission, in violation of Section 4g(1) of the Act and Commission Rules 1.31(a) and 1.35(a). Id. at 44,238.
2. Guttmanís Liability
The ALJ found that Guttman had formed a partnership with Magid in 1987, when the two began opening joint accounts, and that Guttman was involved in the partnership notwithstanding the fact that only Magid engaged in options trading. Id. at†44,233. The ALJ also concluded that Guttman was aware that Gerald would not finance the debit equity in the joint accounts at month-end, that Guttman knew that short-term options financing was contemplated with Glass as the specific counterparty, and that such transactions "were made solely for the purpose of creating artificial equity in the Magid/Guttman accounts." Id. at†44,233-44,234, 44,237. Finally, the ALJ found that, in response to pressure from Raber, Guttman asked Magid to "eliminate the debit margin in the Magid/Guttman accounts for at least the last trading day of the month." Id. at 44,234.
The ALJ concluded that Guttman was not liable as a controlling person under Section 13(b) of the Act because he lacked the ability "to direct Magidís trades." Id. at 44,237. The ALJ acknowledged that evidence relied upon by the Division showed that Magid and Guttman were partners, which involved "sharing the profits, losses and responsibilities of their joint accounts." Id. The ALJ stated, however:
The salient point is that Guttman never traded for the accounts, nor interfered with Magidís trading strategies. While Guttman did put Magid in touch with Glass, the trading scheme was the brainchild of Magid, and was implemented by Magid and Glass. It is this factóthat Magid was the sole decision-maker over all tradingóthat makes it impossible for Guttman to be the controlling person of Magid regarding these trades.
Id. (emphasis in the original). Consequently, the ALJ concluded that Guttman was not liable for Magidís actions under Section 13(b) of the Act. Id.
The ALJ then considered Guttmanís vicarious liability under Section 2(a)(1)(A). At the outset of his analysis, the ALJ observed that this provision, though rooted in the common law doctrine of respondeat superior, was "intended to reach a wider range of relationships." Id. at 44,238. Applying the analysis in Rosenthal†& Co. v. CFTC, 802 F.2d 963, 969 (7th Cir. 1986), the ALJ determined that Magid was acting as Guttmanís agent in executing the trades. Id. In evaluating this issue, the judge noted that Magid and Guttman were equally motivated to eliminate the debit equity in their joint account for their mutual benefit through trading and that they agreed to do so. Id. On the basis of this agreement, as well as Guttmanís subsequent reminders to Magid at the end of each month, the ALJ concluded that Guttman authorized Magid to act for him. Id. Finally, the ALJ found that, in view of Magidís responsibility for options trading for the partnership, Magid was acting within the scope of his employment. Id. Thus, the ALJ concluded, Guttman was liable for Magidís misconduct under Section 2(a)(1)(A). Id.
The ALJ imposed a cease and desist order on Glass. Id. at†44,239-44,240. Finding that Glassís unlawful conduct "directly undermines the integrity of the futures market, [and] was intentional and egregious†.†.†.," the ALJ also imposed a permanent trading ban on Glass. Id. Finally, noting that the mere tripling of the approximately $9,000 gain realized by Glass would not likely deter him from future violations, the ALJ imposed a civil monetary penalty of $150,000. Id.
Turning to Guttman, the ALJ stated:
As the chairman of the NYMEX throughout the relevant time period, Guttman was bound by the highest ethical standards, yet permitted his partner to subvert the free market system through prearranged transactions. Guttmanís gross violations of the Act over a period of six months, especially in light of the fact that he was the chairman of the NYMEX, directly taint the integrity of the futures market and warrant serious sanctions.
Id. at 44,238. The ALJ entered a cease and desist order on the theory that, "[i]f holding the position of chairman of the NYMEX did not stop Guttman from condoning Magidís violations, there is certainly a reasonable possibility that Guttman would repeat the violation when he is no longer the chairman." Id. at 44,239. Finding Guttmanís participation seriously threatening to the integrity of the market, the ALJ imposed a five-year trading ban on Guttman. Id. at†44,240. The ALJ also assessed a $500,000 civil monetary penalty in view of "the flagrant violation of the Act and the frequency of such violations" and Guttmanís gain of $19 million in fictional equity from the six transactions at issue. Id. at†44,239-44,240. Finally, the ALJ concluded that Guttmanís vicarious liability for Magidís violations of Sections 4c(a)(A) and 4c(a)(B) of the Act and Commission Rule 1.38 raised a presumption of unfitness for registration which Guttman had failed to rebut and therefore revoked Guttmanís registration pursuant to Section 8a(2)(E) of the Act. Id. The parties appealed.
The Divisionís Appeal
The Division appeals the ALJís finding that Guttman was not liable as a controlling person, arguing that Guttman: (1) had the power to direct the management and policies of the trading in the Magid/Guttman accounts; (2) was actively involved in the establishment and management of the joint venture, including financing; and (3) had the authority to stop the unlawful trading. (Divisionís Appeal Brief at†28-34.) The Division contends that Guttman knowingly induced Magidís violations or failed to act in good faith. Id. at†36-40. The Division asserts that Guttman knew about the "core elements" of Magidís unlawful trading by virtue of his participation in a meeting in which he, Magid, and Raber discussed the need to eliminate the debit equity in the joint accounts and as a result of subsequent conversations with Glass and Magid. Id. at†38. Finally, the Division asserts that Guttman did not act in good faith because, after delegating to Magid the responsibility for the month-end trades, Guttman only verified that the trades were timely and did not question Magidís methods. Id. at†38-40.
In response, Guttman concedes that he exercised some general authority over the joint accounts but contends that he lacked the power or authority to control the specific trading activity upon which the primary violations were predicated. Guttmanís Answering Brief at†9-15. He distinguishes an equal partner from corporate officers who have positions of authority over subordinates. Id. at†16-19. Guttman contends that the instances in which he exercised authority merely reflect his status as an equal partner rather than "control". Id. at†20. Guttman argues that he did not have the power to stop the violative activity, because he lacked any meaningful knowledge of options trading. Id. at†27. Moreover, Guttman asserts that he had no ability to discipline Magid, stop his trading, or order an investigation. Id. at†29.
Guttman maintains that he did not induce Magidís violations or fail to act in good faith. Id. at†30-38. Guttman contends that his, Raberís, and Glassís testimony constitute reliable evidence and contradict Magidís testimony regarding Guttmanís knowledge of any unlawful trading. Id. at†31-34. Moreover, Guttman asserts that he did not lack good faith because the need for a system of internal supervision was negligible since no customers were involved. Id. at†37. Finally, Guttman claims that, to the extent any system of supervision was required, sole responsibility rested with Magid, who was responsible for all trading in those accounts, and that he had no basis for suspecting that Magid would engage in improper activity. Id.
Guttman seeks reversal of the ALJís finding that he is liable as a principal for Magidís violations under Section 2(a)(1) of the Act. Alternatively, Guttman requests a reduction in the sanctions.
Guttman argues that in imposing liability on him as a principal the ALJ ignored the legislative history of Section 13(b) and misconceived judicial and Commission precedent, which imputes liability for a violation by an agent to the business entity rather than individual persons. (Guttmanís Appeal Brief at†15-22.) Guttman contends that the law governing joint trading accounts does not create a principal-agent relationship. Id. at†23. Guttman argues that principal-agent liability should be limited to reparations or civil damages and cites Commission Rule 3.57 in support of the proposition. ("The Commission will not initiate statutory disqualification proceedings under Section†8a(2)(E) of the Act if respondeat superior is the sole basis upon which the respondent may be subject to a statutory disqualification.") Id. at†26 nn.†16, 57. Additionally, Guttman asserts that the ALJís decision is "marred by procedural and evidentiary errors"ólimiting his right to cross-examine Magid and denying Guttman the right to offer the testimony of a polygraph expert. Id. at†26-40. Guttman also argues that Magidís testimony is not credible because it is inconsistent with the testimony of Raber, Guttman, and Glass, contradicts Magidís deposition, and is self-serving because of a pending civil lawsuit by Magid against Guttman and Magidís settlement agreement with the Commission. Id. at†41-47. Guttman also asserts that the testimony of his character witnesses should be accorded substantial weight. Id. at†44-45.
Finally, Guttman charges that the sanctions are excessive because the ALJ erroneously found that Guttman knew about the execution of the improper trades, the ALJ improperly relied upon Guttmanís status as NYMEX Chairman in assessing sanctions, and the ALJís discussion does not reflect a reasoned application of the factors relevant to an assessment of sanctions. Id. at†47.
Acting pro se, Glass requests that the Commission apply the arguments of Guttman and the amici curiae to him. (Glassís Appeal Brief at†1.) Glass also appears to argue that the ALJ denied him due process by terminating Guttmanís right to cross-examine Magid. Id. at†1-2. Glass further contends that the sanctions imposed on him were unjustified because of the absence of customer loss and that they do not serve the purpose of deterring future violations. Id. at†2.
The CSCE, the Chicago Mercantile Exchange ("CME"), and the Board of Trade of the City of Chicago ("CBOT") jointly filed a brief as amici curiae ("Joint Brief"), which was joined by the New York Cotton Exchange ("NYCE"). In addition, the NYMEX and the Commodity Floor Brokers and Traders Association ("CFBTA") separately filed amicus briefs.
The amici explain that many of their members participate in trading accounts with other traders in which a single person makes the trading decisions. (Joint Brief at†1; CFBTA Brief at†1-2, 7-8.) These amici argue that the imposition of Commission sanctions without a showing of culpability is unconstitutional. (Joint Brief at†2, 3, 7.) Further, they argue that Congress has limited secondary liability for civil penalties to controlling persons who are shown to be culpable. (Joint Brief at†5, 8-9.) They contend that the applicability of secondary liability is limited to reparations and private civil actions. (NYMEX Brief at†2, 7-8; Joint Brief at†8-9.) Finally, the amici express concern that to increase sanctions because the respondent is an officer or director of an exchange will have a chilling effect on their ability to recruit qualified individuals to serve in these capacities. (NYMEX Brief at†1-2, 5-6; Joint Brief at†10-15; CFBTA Brief at†8-9.)
The ALJ found Magidís testimony credible and Glassís testimony not credible. Generally, we defer to the credibility findings of the ALJ. In re Mayer, 1998 WL 80513 at†*31 n.63 (CFTC Feb.†25, 1998) (citing Ahlstedt v. Capitol Commodity Services, Inc., [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 27, 131 at 45,290 n.12 (CFTC Aug. 12, 1997) and In re Abrams, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 26,479 at 43,136 (CFTC July 31, 1995)). Although respondents attack Magidís credibility, neither his settlement with the Division nor the existence of his civil lawsuit against Guttman undermines Magidís credibility so as to justify rejecting the credibility determinations of the ALJ.
Respondents complain that Guttmanís counsel was prevented from adequately cross-examining Magid and, in particular, from showing that Magid was not credible. The hearing transcript reveals that, after Guttmanís attorney established on cross-examination that Magid had a lawsuit pending against Guttman, he asked questions seeking opinion testimony from Magid regarding the influence the lawsuit would have on the current proceeding. (Tr. at 196-200.) The ALJ then asked counsel to limit his questions to matters raised in the direct examination. (Tr. at 200.) Counsel then examined Magid about his settlement with the Commission in which he undertook to cooperate with the Division. (Tr. at†200-204.) The ALJ took official notice of the Commissionís Opinion and Order accepting Magidís settlement offer, but again invited counsel to examine Magid about his direct testimony. (Tr. at 206.) Counsel tried to ask questions about sworn and unsworn statements made previously. (Tr. at 208-211.) The ALJ advised counsel to inquire "of this witness concerning the answers he gave" on direct examination, warned him that if he did not do so the ALJ would conclude the cross-examination, invited counsel to call Magid as a witness for Guttman, and stopped the hearing for five minutes to enable counsel to "think whether you have anything to ask this witness." (Tr. at 211-214.) After the break, counsel again asked questions directed to issues other than Magidís direct testimony, and the ALJ dismissed the witness. (Tr. at 215-217.)
Commission Rule 10.66(c), 17 C.F.R. ß 10.66(c) (1997), provides that "[a] witness may be cross-examined by each adverse party and, in the discretion of the Administrative Law Judge, may be cross-examined, without regard to the scope of direct examination." Courts have recognized that "[t]he right to cross-examine a witness does not mean that a party can do so in Ďwhatever way, and to whatever extentí it desires." In re Rousso, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 27,133 at 45,306 (Aug. 20, 1997), affíd, Nos. 97-4232, 97-4239, 97-4236 and 97-4238 (2d Cir. March†11, 1998). The trier of fact may properly exercise discretion to impose reasonable limits on the scope of cross-examination. Id.; see also Maatschappij v. A.O. Smith Corp., 590 F.2d 415, 421 (2d Cir. 1978); accord, In re Air Disaster at Lockerbie, Scotland on Dec. 21, 1988, 37 F.3d 804, 825 (2d Cir. 1994), cert.† denied, 513 U.S.†1126 (1995).
It was not an abuse of discretion for the ALJ to limit cross-examination generally to the subject matter of Magidís testimony on direct examination. See e.g., Fed.†R.†Evid. 611(b) ("Cross-examination should be limited to the subject matter of the direct examination and matters affecting the credibility of the witness."). The ALJ allowed counsel to raise questions concerning Magidís credibility and to attempt to show the self-serving nature of his testimony. Once these questions were raised and answered, the ALJ did not allow extensive additional inquiry. The ALJ encouraged counsel a number of times to question Magid about matters raised on direct examination and acknowledged counselís right to attempt to impeach Magidís credibility by using evidence outside the direct examination. The ALJ also twice invited counsel to call Magid as a witness in his case-in-chief, during which he could "inquire about matters not raised today." (Tr. at†212, 213.) Guttmanís counsel did not do so. There can be little doubt that such sequencing of testimony was within the ALJís discretion. See Commission Rule†10.8, 17 C.F.R. ß†10.8 (1997) ("The Administrative Law Judge shall be responsible for the fair and orderly conduct of the proceeding and shall have the authority to†.†.†. [r]egulate the course of the hearing†.†.†.†"). See also Fed.†R.†Evid.†611(a) ("The court shall exercise reasonable control over the mode and order of interrogatory witnesses .†.†.†."). Guttmanís counsel nevertheless elected not to call Magid as his own witness. Further, the ALJ twice invited Guttmanís counsel to submit a written offer of proof the following morning. (Tr. at†205, 213.) See†also Commission Rule†10.67(a), 17 C.F.R. ß†10.67(a) (1997).
Several months after the hearing, Guttman submitted a written offer of proof in response to the ALJís invitation at the hearing. Guttmanís offer attempts to discredit Magidís testimony by referring to a number of inconsistencies between Magidís deposition statements and his hearing testimony. This proffer was untimely. Under these circumstances, we believe that Guttman was given ample opportunity to pursue his challenge to Magidís credibility and that the limitations imposed by the ALJ on cross-examination were neither improper nor prejudicial.
The Polygraph Examination
Guttman argues that the ALJ prevented him from receiving a fair trial by excluding his polygraph evidence. On May 10, 1993, the ALJ issued a pre-hearing order directing the parties to submit the direct testimony of expert witnesses in writing no later than August†16, 1993, for the Division and August†30, 1993, for the respondents. On October 13, 1995, less than two weeks before the scheduled hearing, Guttman notified the ALJ for the first time that he was supplementing his witness list with a polygraph expert, even though the polygraph examination had occurred on July 22, 1992, more than three years before the date of the hearing. The Division opposed Guttmanís request on the grounds that the untimely notice violated the ALJís May 1993 prehearing order and that polygraph evidence was unreliable. The ALJ denied Guttman leave to present the polygraph witness.
When our rules do not specifically address an issue, we have looked to the courts for guidance. See FDIC v. Shearson Lehman, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 25,044 at 37,902 (CFTC Apr. 26, 1991); Joubert v. Chartered Systems of New York, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 22,481 at 30,133 (CFTC Jan. 25, 1985). The decision whether to allow testimony of witnesses not described or listed in a pretrial order rests within the sound discretion of the trial judge and generally is not disturbed absent an abuse of discretion. Perry v. Winspur, 782 F.2d 893, 894 (10th Cir. 1986) (citing 3 J. Moore, Mooreís Federal Practice, ß†16.19 at†16-63 (2d ed. 1985)), see also, Harris v. Steelweld Equipment Co., Inc., 869 F.2d 396, 399-400 (8th Cir.), cert. denied, 493 U.S. 817 (1989) (district court did not abuse its discretion by excluding an expert witness who was not timely disclosed pursuant to the local rule).
In determining whether a judge has abused his discretion, courts look to the following factors:
(1) the prejudice or surprise in fact of the party against whom the excluded witnesses would have testified, (2) the ability of that party to cure the prejudice, (3) the extent to which waiver of the rules against calling unlisted witnesses would disrupt the orderly and efficient trial of the case or of other cases in court, and (4) bad faith or willfulness in failing to comply with the [pre-hearing] order.
Perry, 782 F.2d†at 893 (citing Smith v. Ford Motor Co., 626 F.2d 784, 797 (10th Cir. 1980), cert.†denied, 450 US.†918 (1981) (quoting Meyers v. Pennypack Woods Home Ownership Assín, 559 F.2d 894, 904-905 (3d Cir. 1977)).
Those courts which admit polygraph evidence generally do so only when there are procedural protections for the opposing party. United States v. Posado, 57 F.3d 428, 435 (5th Cir. 1995) ("[t]he prosecution was contacted before the tests were conducted and offered the opportunity to participate in the exams . . . . In such a case, both parties have a risk in the outcome of the polygraph examination, simultaneously reducing the possibility of unfair prejudice and increasing reliability."); United States v. Crumby, 895 F. Supp. 1354, 1364-1365 (D. Ariz. 1995) (admitting polygraph evidence subject to requirements that the opposing party, among other things, be given sufficient notice and a reasonable opportunity to have its own competent examiner administer a polygraph examination which is materially similar to the previously taken examination.)
Admission of the polygraph evidence in this case would have prejudiced the Division. Guttman failed to notify the Division of the polygraph examination before it was conducted; the Division had no opportunity to provide input as to the questions the examiner asked; and the Division had insufficient time to obtain its own polygraph examination. Consequently, a continuance in order to conduct further polygraph tests would have been necessary.
In the absence of a showing of good cause by the proponent of the witness, an ALJ is not required to grant postponements in order to dispel prejudice to the Division from untimely identification of expert witnesses. Perkasie Industries Corp. v. Advance Transformer, Inc., 143 F.R.D. 73, 77 (E.D. Pa. June 11, 1992). This is especially so where, as here, the polygraph examination was taken several years earlier and the respondent offered no explanation for his failure to comply with the ALJís prehearing order. Moreover, even if Guttmanís counsel had complied with the prehearing order, the Supreme Courtís recent decision in United States v. Scheffer, 1998 WL†141151 (U.S. 1998), would support the conclusion that the ALJ had the discretion to exclude the polygraph test on grounds of unreliability. We find that the ALJ did not abuse his discretion by excluding the polygraph testimony.
"[T]he central characteristic†.†.†.†of fictitious sales, is the use of trading techniques that give the appearance of submitting trades to the open market while negating" risk or price competition. In re Collins, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 22,982 at 31,902 (CFTC Apr. 4, 1986), clarified, ∂†23,401 (CFTC Nov. 26, 1986), revíd on other grounds sub nom. Stoller v. CFTC, 834 F.2d 262 (2d Cir. 1987). Wash sales and accommodation trades are forms of fictitious trades.
In wash sales, for example, purchases and sales are made in the pit, but the financial result is close to or equal to zero. By effectively buying and selling to himself, a trader eliminates or sharply reduces his risk of loss. Moreover, because the price of the buy and sell orders is of little consequence as long as the wash result is achieved, price competition may also be negated. Id. at†31,902-31,903.
The intentional creation of a nullity is not deemed a bona fide transaction "even when the traderís facially independent purchase and sale are executed by open and competitive outcry." In re Bear, Stearns†& Co., [1990-1992 Transfer Binder] Comm. Fut.†L.†Rep. (CCH) ∂ 24,994 at 37,663 (CFTC Jan.†25, 1991).
Generally, Glass traded in the coffee and cocoa pits. Glass did not trade in the sugar pit between March and September 1989 except in connection with the 12 Appendix†A trades that he executed opposite Magid. Appendix A reveals a pattern of fictitious trading. In virtually all of the transactions, trades were executed in the sugar pit on the last trading day of the month, and offsetting positions were executed on the first trading day of the following month. The trades executed on the last trading day of the month were high risk in nature, exposing the accounts to considerable losses. The trades on the last day of the month were executed for the same quantity of the same contract at the same strike price as the offsetting trades on the first trading day of the following month. The only differences between the two sets of transactions were in the spread premiums, which were just enough to cover Glassís costs. The only two participants in these trade sequences were Magid and Glass. Magid testified that he prearranged the trades with Glass. The ALJ found this testimony credible. Glass, ∂ 26,787 at 44,236.
There is no question that Magid and Glass intended to create a financial nullity. There is no discernible legitimate purpose for the trades in Appendix A. Magidís only purpose was to finance the debit equity in the account for the month-end. Magid thus executed positions, which he nullified the following trading day. Further, the evidence indicates that Magid and Glass negated market risk by agreeing in advance to offset the trades with each other.
Prearrangement is one of the more common forms of fictitious sales forbidden by Section 4c(a)(A) and is a form of anticompetitive trading that violates Commission Rule 1.38. Mayer, 1998 WL†80513 at†*22. The transaction may appear to be the result of open outcry, but negates both the risk and price competition incident to an open outcry market because it is in reality a private transaction arranged outside the trading pit. Id. (citing Collins ∂ 22,982 at 31,903; In re Gimbel, [1987-1990 Transfer Binder] Comm.†Fut. L. Rep. (CCH) ∂ 24,213 at 35,003 (CFTC Apr. 14, 1988)). When a prearranged transaction in the pit is structured to produce a wash result, it is both a fictitious sale and a wash sale under Section 4c(a)(A) of the Act. Id. Accommodation trading is non-competitive trading entered into by a trader to assist another with unlawful trading. The essential characteristic of a wash sale is the intent not to take a genuine, bona fide position in the market. Sundheimer v. CFTC, 688 F.2d 150, 152 (2d Cir. 1982), cert. denied, 460 U.S. 1022 (1983). "It is this intent, the absence of good-faith, arms length trading, and the undisclosed prearrangement for losses and gains, that demonstrates the Ďaccommodationí nature of the transactions in the instant case." Id.
Glass has presented no credible explanation as to how he came to be in the sugar pit at just the time that Magid needed to do a month-end trade. Nor has he explained why he was willing to engage in such high risk trades in a commodity in which he was not accustomed to trading. The only plausible explanation is that, as Magid testified, Glass and Magid agreed beforehand to execute the offsetting trades. Accordingly, we affirm the ALJís finding that Glass engaged in noncompetitive trading in violation of Commission Rule†1.38 and accommodated Magid in executing prearranged wash trades in violation of Section 4c(a)(A) of the Act.
Glass was charged with reporting, and the ALJ found that Glass had reported, non-bona fide prices. The only bona fide prices are those obtained competitively in the pit. Mayer, 1998 WL†80513 at†*26 (citing In re Murphy, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 22,798 at 31,352 (CFTC Sept. 25, 1985)). The Appendix A trades were not executed competitively. Accordingly, we find that Glass reported non-bona fide prices in violation of Section 4c(a)(B) of the Act.
Finally, the record is uncontroverted that Glass failed to produce copies of his records of his transactions as required by Section 4g(1) of the Act and Commission Rules 1.31 and 1.35. Accordingly, we find that Glass violated Section 4g(1) of the Act and Commission Rules 1.31 and 1.35.
Control Person Liability Under Section 13(b)
Under Section 13(b) of the Act, any person who controls any person who has violated the Act may be held liable to the same extent as the controlled person when the Division proves that the controlling person did not act in good faith or knowingly induced the acts constituting the violation. A fundamental purpose of Section 13(b) is to allow the Commission to reach behind the business entity to its controlling individual and to impose liability for violations of the Act directly on such individual as well as on the entity itself. In re Apache Trading Corp., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂†25,251 at 38,794 (CFTC Mar.†11, 1992), citing In re Big Red Corp., [1984-1986 Transfer Binder] Comm.†Fut.†L.†Rep. (CCH) ∂†22,623 (CFTC June†7, 1985), affíd sub nom. Rosenthal & Co. v. CFTC, 802 F.2d 963 (7th Cir. 1986).
Control is the direct or indirect power to direct or cause the direction of the management and policies of a person. In re Spiegel, [1987-1990 Transfer Binder] Comm. Fut. Law Rep. (CCH) ∂ 24,103 at 34,765 n.4 (CFTC Jan 12, 1988); see also In re GNP [1990-1992 Transfer Binder] Comm. Fut. Law Rep. (CCH) ∂ 25,360 at 39,216 (CFTC Aug. 11, 1992). Failure to exercise such authority, or acquiescence in the usurpation of such authority by another, does not negate a case of control. In re Spiegel, ∂†24,103 at†34,765 n.4 (CFTC Jan. 12, 1988). See also Monieson v CFTC, 996 F.2d 852, 859 (7th Cir. 1993), quoting Donohoe v. Consolidated Operating & Production Corp., 982 F.2d 1130, 1138 (7th Cir. 1992) ("Control person liability will attach if such a person possessed the power or ability to control the specific transaction or activity upon which the primary violation was predicated, even if such power was not exercised."). Determination of whether a person is a controlling person is fact specific and requires a thorough examination of all of the circumstances. See, e.g., Spiegel, ∂†24,360 at 34,765, 34,768; Apache ∂ 25,251 at 38,794-38,795; GNP, ∂ 25,360 at 39,216.
The sole basis for the ALJís determination that Guttman was not a controlling person under Section 13(b) of the Act was his finding that Guttman did not control Magidís trading. The ALJ found that Guttman did not trade for the accounts or interfere with Magidís trading strategy and that Magid was the sole decisionmaker for all trading. Glass, ∂ 26,787 at 44,237. However, the ALJís conclusion is inconsistent with the language of Section 13(b), which speaks to whether a person "directly or indirectly" had the power to control the activity in question. Control includes the authority to tell someone what not to do as well as the authority to tell the person what to do. Thus, if Guttman had sufficient control either to direct or to interfere with the partnershipís unlawful trading activity, it is not necessary that Guttman actually dictate the specifics of the trading in order for him to have been a controlling person of the partnership.
Guttman and Magid jointly formed a trading partnership, which included joint accounts and financing arrangements. Initially, Guttman and Magid contributed equal amounts of trading capital. Guttman agreed to share equally his brokerage revenues from Gerald and gave Magid the use of one of his trading seats. Magid provided trading expertise for his and Guttmanís behalf. Shortly after the partnershipís inception, Guttman and Magid formed HF to fund salaries and provide operational support. Guttman assigned to HF the revenue from his contract with Gerald and, eventually, his NYMEX stipend.
In addition to pooling their resources and dividing the profits, Guttman and Magid divided their responsibilities. The two partners initially agreed that Guttman would take care of the administrative duties and obtain financing and that Magid would trade the joint accounts pursuant to his options strategy. As one of two co-equal partners, Guttman could have renegotiated or terminated the partnership agreement at any time. Ebker v. Tan Jay International Ltd., 741 F.Supp.†448, 468 (S.D.N.Y. 1990), affíd, 930 F.2d†909 (2d Cir. 1991) ("A partnership at will may be dissolved at the will of either of the partners on a momentís notice without liability for breach of contract.†.†. . The dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business; dissolution occurs when a partner manifests an unequivocal election to dissolve the partnership."); Hirsch v. du Pont, 396 F.Supp.†1214, 1221 (S.D.N.Y. 1975), affíd, 553 F. 2d†750 (2d Cir. 1977) ("[U]nder ßß †40(5) and 98(1), N.Y. Partnership Law, Ď[a]ll [general] partners have equal rights in the management and conduct of the partnership business * * * .í But this right is Ďsubject to any agreement between them.í ").
The deficit in the Magid/Guttman account grew to a point where it hurt Geraldís balance sheet. Raber expressed Geraldís willingness to carry the Magid/Guttman intra-month deficit as long as the account showed no deficit at month-end. Consequently, to show a reduction of Geraldís deficit, Guttman and Magid agreed to do month-end prearranged trades which would transfer the needed funds into the accounts temporarily and would transfer them out shortly thereafter, thereby reducing the deficit temporarily on Geraldís balance sheet.
The decision to do the prearranged trading in question for the purpose of obviating the need to obtain greater financing of the joint account involved both partners. Guttman was involved in determining how to meet the partnershipís financing needs and agreeing to the prearranged trading strategy to satisfy their clearing firm. Magidís input was necessary to determine feasibility of this kind of trading strategy and the details of the executions. Although Magid was given responsibility for executing the trades, Guttman still controlled the implementation of this financing strategy. The trading activity undertaken to reduce the deficit in the account required consultation between the two partners, and the trades were executed by Magid only after the two partners consulted and agreed on a trading strategy. Guttman made the initial contact with Glass to enlist him as an accommodator in the prearranged trades and was fully informed by Magid of the basic strategy to enter prearranged strangles with Glass. Guttman repeatedly asked Magid to eliminate the deficit in the account on the last trading day of the month through such transactions.
The evidence amply demonstrates that Guttman had the power to control the trading activity. Guttman significantly affected the trading in the account by providing Magid with the cash necessary to trade the account, by arranging for deficit financing, and by having Gerald refrain from collecting the required margin. Guttman exercised control over the joint account by transferring funds from the joint account to his personal account and by allowing Gerald to place losing positions in the joint account. Guttman also possessed the power to withdraw funds from the joint account and to dissolve the partnership, which demonstrates his ability to control whether Magid traded at all for the joint account. See Merriman v. Town of Colonie, 934 F.Supp. 501, 505-506 (N.D. N.Y. 1996), affíd, Merriman v. Ye Ole Locksmith Shoppe, Inc., 112 F.3d 504 (2nd Cir. 1997) (as long as the partnership is in existence, partners have equal access to partnership property); Taylor v. Millard, 118 N.Y. 244, 249-250, 23 N.E. 376 (N.Y. App. Div. 1890) ("A tenancy in common exists when there is unity of possession. . . . [E]ach tenant owns an undivided fraction. . . ."); Napoli v. Domnitch, 18 A.D.2d 707, 236 N.Y.S. 2d 549, 551 (N.Y. App. Div. 1962), affíd, 197 N.E.2d†623 (1964) ("No one can be forced to continue as a partner against his will."). While Guttman may not have directed how each trade was executed, Guttman indirectly controlled the trading activity by controlling the resources of the trading and by determining that it was necessary for Magid to execute the prearranged trades for the purpose of appearing to reduce the deficit in the account. Accordingly, we find that Guttman was a controlling person with regard to the trading in the joint account.
In order to prove that Guttman is liable under Section 13(b) of the Act, the Division must prove that Guttman either knowingly induced the violation, directly or indirectly, or that Guttman failed to act in good faith. CFTC v. Standard Forex, Inc., [1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂†26,063, at 41,457 (E.D.N.Y. Aug.†9, 1993); Apache, ∂†25,251 at 38,794, citing Spiegel, ∂†24,103 at†34,766. In other words, a controlling person must be culpable. Standard Forex, Inc., ∂†26,063 at 41,457. A controlling personís liability does not require involvement with the actual transactions; it is his or her knowledge of the transactions and how they were handled that is significant. See Spiegel, ∂ 24,103 at 34,767 (citing San Francisco-Oklahoma Petroleum Exploration v. Carstan Oil Company, 765 F.2d 962, 964-965 (10th Cir. 1985)). For the Division to show knowing inducement under Section 13(b) of the Act, the Division must show that the controlling person had knowledge of the core activities that constitute the violation at issue and allowed them to continue. Speigel, ∂ 24,103 at 34,767.
When Magidís trading strategy began to generate very large open positions, Guttman arranged additional financing, first through BBH and then with Gerald. Eventually the account debit was so large that Guttman was unable to obtain additional financing for Magidís trading positions. Guttman could have insisted that Magid liquidate the positions. If Magid had refused, Guttman could have exercised his joint control over the accounts by requiring liquidation of the account and withdrawing from the partnership. Instead, Guttman facilitated further trading of large open positions by persuading Gerald, with Magidís assistance, to finance the debit by not collecting margin in exchange for promised interest on the deficit in the account. Guttman thus enabled Magid to continue trading by arranging for non-collection of the margin on the positions in the joint account.
At the meeting in February or March 1989, Raber, Guttman, and Magid discussed the use of box transactions solely for the purpose of appearing to eliminate the month-end debit equity. It was understood that the transactions were to be initiated and offset within a few days at most. Glass was identified as one of several potential counterparties before the first transaction set forth in Appendix A was executed. Moreover, no other possible counterparties were contacted. As the ALJ found, Guttman approached Glass to determine whether he was willing to be a counterparty to the prearranged trades. Guttman told Magid that he had spoken to Glass and that Glass would be interested in the prearranged trading as long as the trades were unwound within a couple of days.
Given Guttmanís concern with financing, it would have made little sense for Guttman to have Magid execute trades for the purpose of appearing to finance the debit in the account if the trades would not accomplish that purpose. The creation of artificial equity in the accounts could only work if the account was not subjected to additional risk. Thus, Guttman and Magid initially discussed the use of box trades, which were limited in risk. Ultimately, Magid agreed with Glass to do prearranged strangles because the transaction fees for strangles were less than the fees for boxes. Strangles are inherently riskier than boxes. However, the risk associated with strangles can be substantially reduced with a prior arrangement for a wash trade. Magid informed Guttman about his agreement with Glass to execute prearranged strangles and the potential risk if Glass did not honor his side of the agreement and there was a substantial move in the market. Guttman assured Magid that Glass would keep his word. Magid also informed Guttman that Glass had told him that he needed only his costs as compensation for doing the trades. Through Magidís reports to Guttman, Guttman knew, even before the first trade was executed, that Magid had prearranged with Glass to purchase and sell contracts at the same or similar prices and that Magid was planning to trade with Glass with no appreciable cost or risk to the joint account. Guttmanís agreement to pursue the prearranged trading strategy, his failure to stop the prearranged wash transactions and his continued involvement and participation in the joint account during the period constitutes a knowing inducement of unlawful trading. Consequently, we find that Guttman had knowledge of the unlawful activities and allowed them to continue. See Spiegel ∂†24,103 at†34,767. Accordingly, we find that Guttman is liable as a controlling person under Section 13(b) of the Act.
Agency Liability Under Section†2(a)(1)
We also find Guttman liable under Section†2(a)(1) of the Act. Whether one person is an agent acting on behalf of another person is a fact-intensive inquiry based upon an overall assessment of the totality of the circumstances of each case. Stotler and Co. v. CFTC, 855 F.2d†1288, 1292 (7th cir. 1988); Wirth v. T&S Commodities, Inc., [1990-1992 Transfer Binder] Comm.†Fut.†L.†Rep. (CCH) ∂†25,271 at†38,875 (CFTC Apr.†6, 1992); Berisko v. Eastern Capital Corp., [1984-1986 Transfer Binder] Comm.†Fut.†L.†Rep. (CCH) ∂†22,772 at 31,223 (CFTC Oct.†1, 1985). Guttmanís knowledge of and control over Magidís violations of the Act establishes that Magid was "acting for" Guttman individually, within the meaning of Section 2(a)(1). While actual participation in the agentís wrongful conduct is not required to hold a principal liable under Section†2(a)(1)(A), our precedent establishes that, where a partnership is concerned, active participation in the agentís wrongdoing will serve as a basis for holding the partners individually liable. Kessenich v. Rosenthal†& Co., [1980-1982 Transfer Binder] Comm.†Fut.†L.†Rep. (CCH) ∂†21,181 at†24,866 n.†15 (CFTC Mar.†24, 1981), appeal dismissed sub nom. Kessenich v. CFTC, 684 F.2d 88 (D.C. Cir. 1982); In re Bamaodah, [1986-1987 Transfer Binder] Comm.†Fut.†L.†Rep. (CCH) ∂†23,010 at†31,997 (CFTC Apr.†18, 1986); In Rosenthal†& Co., [1984-1986 Transfer Binder] Comm.†Fut.†L.†Rep. (CCH) ∂†22,221 at†29,180 (CFTC June†6, 1984). Here, the record demonstrates that Guttman actively participated in the development and implementation of the illegal trading practices of his partner, Magid.
Once an agency relationship is established, the focus of the inquiry is upon whether the agent was acting for the principal within the scope of his employment or office. Rosenthal, 802 F.2d at†966; Lobb v. J.T. McKerr & Co., [1987-1990 Transfer Binder] Comm.†Fut.†L.†Rep. (CcH) ∂†24,568 at†36,441 (CFTC Dec.†14, 1989). Here, Guttman joined in a trading enterprise with Magid in order to take advantage of Magidís experience and expertise trading options. Trading options, including the unlawful transactions, was Magidís principal partnership responsibility. Magidís violations resulted from a direction from Guttman to implement a financing strategy that Guttman knew would involve unlawful trading. Magidís misconduct was plainly within the scope of his employment and in furtherance of their joint financial interests.
We need not consider whether Guttman would be liable under Section†2(a)(1)(A) of the Act on pure respondeat superior principles if he had had no knowledge of the violations by Magid. Where such knowledge is present, we do not believe that a finding of liability under Section†13(b) precludes liability under Section†2(a)(1)(A). The former provision is designed to supplement, rather than replace, respondeat superior liability by adding controlling person liability. See, Rosenthal, 802 F.2d at†966-67; Dohmen-Ramirez v. CFTC, 837 F.2d†847 (9th Cir. 1988); Big Red Commodity Corp., ∂†22,623 at†30,667-669.
The ALJ imposed a cease and desist order, a civil monetary penalty of $150,000 and a permanent trading ban on Glass. With respect to Guttman, the ALJ imposed a cease and desist order and a $500,000 civil monetary penalty, revoked his registration, and imposed a five-year trading ban.
Glass contends that the sanctions imposed by the ALJ are irrational and that the $150,000 civil monetary penalty and permanent trading ban are too severe in light of the absence of customer losses.
Guttman also argues that the sanctions imposed by the ALJ are excessive. Guttman submits that there is no basis to support a $500,000 civil monetary penalty. (Guttman Appeal Brief at†49-53.) Guttman asserts that the trades "were not entered into for a profit motive; instead, they were conducted simply as a means of satisfying Geraldís request to reduce debit equity at month-end." Id. at†51. Guttman contends that there were no victims and that the penalty is not comparable to the civil monetary penalties imposed in similar cases. Id. Guttman argues that the nexus between his violation and the integrity of the futures markets is weak, rendering a five-year trading ban excessive. Id. at†54. Guttman also contends that the ALJís finding of vicarious liability does not provide a basis for the revocation of his registration under Section 8a(2)(E) of the Act, especially in light of Commission Rule 3.57, which states that "[t]he Commission will not initiate a proceeding under section 8a(2)(E) of the Act, if respondeat superior is the sole basis upon which the registrant may be found subject to a statutory disqualification." Id. at†57. Additionally, Guttman argues that a cease and desist order is inappropriate because there is no evidence that the conduct will be repeated. Id. at†55-57. He maintains that the violative activities were confined to the trades listed in Appendix A and that they were conducted by Magid. Id. at†56. Further, Guttman argues that the ALJ increased the sanctions because of his position as president of NYMEX, which he contends is an inappropriate factor to consider. Id. at†47.
In enforcement proceedings we impose sanctions "to further the Actís remedial policies and to deter others in the industry from committing similar violations." In re Volume Investors Corp., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 25,234 at 38,679 (CFTC Feb. 10, 1992). In determining the measure of damages commensurate with the gravity of the violation, we are not limited by the sanctions chosen by the ALJ, but exercise our independent judgment. In re Grossfeld, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 26,921 at 44,467 (CFTC Dec. 10, 1996), affíd sub†nom. Grossfeld v. CFTC, 1998 WL†138757 (11th Cir. 1998). We do not rely on a specific formula in assessing de novo the appropriate level of sanctions, but instead we look to the total facts and circumstances of the case and focus on the relative gravity of respondentsí misconduct in light of the following factors: (1) the relationship of the violation at issue to the regulatory purposes of the Act; (2) the respondentís state of mind; (3) the consequences flowing from the violative conduct; and (4) respondentís post-violation conduct. Id. at†44,467-44,468. We also consider any mitigating or aggravating circumstances presented by the facts. Id. at†44,468.
Magid and Glass, during a period of many months, knowingly engaged in six sets of prearranged transactions, by executing transactions on the last trading day of the month which they reversed by agreement on the first trading day of the following month, resulting in a wash. The purpose of the trades was to remove, temporarily, a deficit from the account owned by Magid and Guttman. No risk was taken; no true price discovery occurred. Indeed, enormous prearranged transactions occurred solely for the purpose of allowing Magid and Guttman to continue to trade without adequate financial resources. Respondentsí prearranged wash trading undermined the open outcry system of trading and threatened the integrity of the market.
We have found that Guttman was a controlling person in the unlawful trading scheme. Guttman knowingly induced the prearrangement of the trades and did not act in good faith to stop Magid and Glass from engaging in noncompetitive trade practices.
Neither respondent has submitted evidence of rehabilitation, and consequently we make no finding that respondents have been rehabilitated.
1. Cease and Desist Order
Cease and desist orders are appropriate where there is a reasonable likelihood the conduct will be repeated. In re GNP Commodities, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 25,360 at 39,223 (CFTC Aug. 11, 1992). One indicator of the likelihood of future violations is the existence of a pattern of past conduct. Id. Glass was disciplined by the Commission previously for trade practice violations occurring in 1977-1978. In re Buckwalter, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 24,995 (CFTC Jan. 25, 1991); In re Bear Stearns & Co., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 24,994 (CFTC Jan. 25, 1991). Glass is now again before the Commission for trade practice violations. In 1976 Guttman was permanently enjoined from future violations of the federal securities laws. SEC v. Commonwealth Chemical Securities, 410 F.Supp. 1002, 1020 (S.D.N.Y. 1976), affíd in part, modified in part, 574 F.2d†90 (2d Cir.†1978). Since both Guttman and Glass have histories of past misconduct and since we have found that they were engaged in a series of serious violations extending over a protracted period, a cease and desist order is appropriate as to both respondents. Accordingly, Glass and Guttman are ordered to cease and desist from violating the Act and Commission Rules.
2. Registration Revocation
Under Section 8a(3)(A) of the Act, 7 U.S.C. 12a(3)(A) (1988), the Commission is authorized to "refuse to register†. . . any person†. . . found†. . . to have violated†. . . any provision of [this] Act, or any rule, regulation or order thereunder† . . . or to have willfully aided, abetted, counseled, commanded, induced, or procured the violation by any other person†. . . ." Guttman has violated provisions of the Act and is subject to statutory disqualification from registration. As a result, he is subject to revocation of his registration under Section†8a(4), 7 U.S.C. ß†12a(4) (1994). Guttmanís history of violations establishes that his registration should be revoked.
In 1981, the Commission denied Guttmanís application for registration because of his misconduct underlying an order of the U.S. District Court for the Southern District of New York, Commonwealth Chemical Securities, finding that Guttman violated the antifraud and bookkeeping provisions of the federal securities laws, permanently enjoining him from further violations, and requiring disgorgement of profits by Guttman and other defendants. In re Guttman, [1980-1982 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂†21,191 (CFTC Mar. 30, 1981). Even though we would have been able to refuse to register Guttman under Section 8a(3)(B) (1985), we nonetheless gave Guttman a second chance and allowed him to register in 1986.
Guttman has breached the trust which we placed in him. Guttman has committed further violations by participating in violations which seriously damage the integrity of the futures markets. Guttmanís breach of this trust and his failure to abide by the rules and live up to the second chance given to him make it appropriate that his registration be revoked. Such a pattern of deceptive trading practices establishes a strong likelihood that the wrongdoing will be repeated. In re Cox, [Current Transfer Binder] Comm.†Fut.†L.†Rep. (CCH) ∂†26,939 at†44,531 (CFTC†Jan.†17, 1997) (citing 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)), affíd†sub†nom. Cox v. CFTC, 1998 WL†89141 (7th Cir. 1998). To ensure against such conduct in the future, we conclude that the public interest will best be served by revocation of Guttmanís registration. Cf. Mayer, 1998 WL80513 *29 (citing In re Sundheimer, [1980-1982 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 21,245 at 25,220 (CFTC Sept. 16, 1981), affíd sub†nom. Sundheimer v. CFTC, 688 F.2d 150 (2d Cir. 1982), cert. denied, 460 U.S. 1022 (1983)). Accordingly, we revoke Guttmanís registration.
Since the Commission already revoked Glassís registration in 1991, we need not consider whether to revoke it at this time.
3. Trading Prohibition
The Commission articulated standards for establishing trading prohibitions in In re Citadel Trading Co. of Chicago, Ltd., [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 23,082 at 32,191 (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 offense, the length of the ban, and the impact the ban will have on the respondent.
Where, as here, the proven offenses directly harm the integrity of the market and occur on the floor of the exchange, the nexus requirement is met. In re Murphy, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂ 22,798 at 31,355-31,356 (CFTC Sept. 25, 1985).
The Commission has held that the imposition of a trading ban is appropriate when there has been "an injury to the integrity of the market in the public eye." In re Miller, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ∂†26,440 at†42,913-42,914) (CFTC June 16, 1995) (citing Monieson, 996 F.2d at 863)). Glassís prearranged wash trades represented the sort of repeated and direct assaults on the integrity of the marketplace that erode public confidence in futures markets. Glass traded with Magid for the benefit of both Magid and Guttman. Guttmanís involvement in the scheme to execute the illicit trading carried out on the floor of the exchange by Glass and Magid directly ties him to the offenses and provides the nexus required for imposition of a trading ban. Respondentsí disregard for the underlying purposes of the futures market presents the likelihood of a continuing risk to the market. Both Glass and Guttman have been found guilty of earlier violations and thus have demonstrated their unwillingness to conduct themselves in compliance with the law. Accordingly, they are both prohibited from trading on the markets regulated by the Commission on a permanent basis.
4. Civil Monetary Penalties
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. 24, 1989). Respondentsí violations go to the core of the Act. Their violations were committed knowingly and involved twelve prearranged wash transactions over a period of many months. Moreover, respondents previously violated laws protecting the integrity of U.S. markets.
The penalties that we impose on these respondents reflect and seek to deter the betrayal of the public interest inherent in respondentsí abuse of a regulated public market. We find that the $150,000 civil monetary penalty assessed by the ALJ on Glass insufficiently reflects the gravity of these violations and increase the penalty to $300,000. Moreover, we conclude that the $500,000 civil monetary penalty imposed on Guttman by the ALJ is appropriate in light of the fact that the illegal transactions were for his direct benefit in maintaining the Magid/Guttman account without sufficient financing. Glass, on the other hand, acted as an accommodator. This amount reflects the gravity of the violations and is comparable to other trade practice cases in which civil monetary penalties were assessed.
In light of the foregoing, the ALJís decision is affirmed in part and reversed in part. The cease and desist order, registration revocation, trading bans, and civil monetary penalties, as modified, shall become effective 30 days after this order is served.
IT IS SO ORDERED.
By the Commission (Chairperson BORN, Commissioners TULL, HOLUM and SPEARS).
Jean A. Webb
Secretary of the Commission
Commodity Futures Trading Commission
Dated: April 27, 1998