UNITED STATES OF AMERICA
COMMODITY FUTURES TRADING COMMISSION
In the Matter of
JERRY W. SLUSSER, FIRST REPUBLIC
CFTC Docket No. 94-14
OPINION AND ORDER
This appeal arises out of a multi-count complaint filed in May 1994 by the Division of Enforcement ("Division"). The complaint focused on the respondents' fraudulent misappropriation of approximately $12 million that had been invested in commodity pools under the respondents' control. 1 Following an evidentiary hearing in October 1997 and an evaluation of the record developed by the parties, the administrative law judge ("ALJ") found the respondents liable on all counts of the complaint. The respondents were ordered to cease and desist from further violations of the Commodity Exchange Act ("CEA" or the "Act") and Commission regulations, were permanently banned from trading on or subject to the rules of any contract market, and were found jointly and severally liable for a civil monetary penalty of $10 million. Finally, the ALJ revoked First Republic Trading Corporation's registration as an IB and Jerry Slusser's registration as an AP of First Republic Trading Corporation.
The respondents raise both procedural and substantive challenges to the initial decision, contending among other things that the record does not support the ALJs liability findings, and that the civil monetary penalty imposed by the ALJ was time-barred, excessive, and inconsistent with Commission precedent.
Based on our independent assessment of the record, we conclude that the record amply supports the ALJ's liability conclusions. Moreover, we find that his imposition of a $10 million civil penalty was commensurate with the gravity of the respondents' misconduct, and was neither time-barred nor excessive. Accordingly, we affirm all aspects of the initial decision.
The Respondents 2
Jerry Slusser, at all relevant times a resident of Indiana, was the sole shareholder of First Republic Financial Corporation, an Indiana corporation formerly known and referred to herein as Vancorp Financial Services ("VFS"). VFS in turn was the sole shareholder of First Republic Trading Corporation ("FR Trading") and First Republic Securities ("FR Securities").3 VFS has never been registered with the Commission in any capacity. At all times relevant to the Division's complaint, Slusser was chairman of the board and directed and controlled the operations of each of these entities. Slusser has been registered with the Commission as an associated person ("AP") of FR Trading since September 1990.
FR Trading, also an Indiana Corporation, was acquired by VFS as a wholly owned subsidiary on July 13, 1989. Prior to that date, it had no known relationship with VFS and was a Tennessee corporation known as CMW, Inc. FR Trading has been registered with the Commission as an introducing broker ("IB") since November 1987.
At the heart of this case is the disappearance of approximately $12 million in connection with the respondents' involvement in at least two investment funds. The funds originally were managed by International Participation Corporation ("IPC"), a California corporation that had, between 1987 and 1989, raised approximately $50 million from individuals in Germany for aggregation and subsequent investment in seven separate funds. No disclosure documents were ever filed with the Commission in connection with the IPC funds. IPC used a single prospectus and participation agreement dated November 1, 1988 (collectively, the "prospectus"), in connection with its offer and sale of these investment funds, which included at least two commodity pools: IPC Fund III and IPC Fund IV. Under the terms of the prospectus, IPC Funds III and IV were to be invested exclusively in financial futures and traded on an exchange through an experienced and licensed broker. Pursuant to the prospectus, participants in IPC Funds III and IV were to receive 65 percent of the income earned from trading financial futures. The remaining 35 percent was to be paid to IPC to cover its operating expenses; IPC also collected a 10 percent premium above the subscription amount for commissions and costs. Each of the pools was to stop trading in the event that it lost a specified percentage of the funds invested-10 percent for Fund III and 35 percent for Fund IV.
Respondent Slusser, through VFS and its subsidiaries FR Trading and FR Securities, gained control of the IPC funds and agreed to manage and invest the funds on behalf of the IPC investors through two agreements dated February 13, 1989 (the "February Agreement") and May 31, 1989 (the "May Agrement"), respectively. Between February and July 1989, VFS received approximately $29 million for investment under these agreements and deposited the funds in several banks accounts opened by VFS for that purpose. During the period when VFS traded for the IPC pools-February through November 1989-the pools suffered net losses of $6,586,116. Of that amount, $3,031,574 was lost trading securities in contravention of the prospectus. All but $776,563 of the losses were sustained after May 26, 1989. When the funds were liquidated in November 1989 by order of German authorities, only $16,633,546 was returned to Germany to be distributed to the IPC investors. The respondents claim that the $12 million difference can be explained by a combination of trading losses, commissions and fees. Their explanation may be literally true. However, neither the commissions and fees nor the securities trading were authorized by the IPC prospectus. Approximately three-quarters of the $12 million at issue represents unauthorized fees and commissions misappropriated by the respondents; an additional $3 million was lost trading securities under a prospectus and agreements that limited the respondents' trading to commodity futures contracts.
The Respondents' Activities Under the February Agreement
On February 13, 1989, Jerry Slusser and Hans Brinks, on behalf of VFS, entered into an agreement with two IPC directors on behalf of Eurocalcorp, Ltd. ("Eurocal), an entity incorporated in California and in the Guernsey Channel Islands (the "February Agreement).4 Under the February Agreement, the respondents agreed to manage and invest the IPC funds on behalf of the IPC investors in exchange for a specified share of the profits from trading after the custodial clients had been paid their profits.5 Although the respondents maintain that the funds did not come from IPC participants-or, alternatively, that Slusser was unaware of the source of the funds-the record is replete with documentary evidence establishing that Slusser and VFS knew the origin of the funds.6 Neither the February Agreement nor the IPC prospectus provided for any other form of compensation or expense reimbursement to VFS; between February 13 and May 31, 1989, VFS had no other agreements with or relating to Eurocalcorp or IPC.7
Between February 28 and July 14, 1989, VFS received approximately $29 million from the IPC Funds and IPC participants. All of the IPC money was deposited into VFS bank accounts bearing the names of Vancorp, VFS or Sterling Bank ("Sterling"). Approximately $18 million was transferred from IPC, and the remaining $11 million was deposited directly by IPC participants. On March 14, 1989, at Slusser's direction, a letter on Sterling letterhead was sent to IPC management confirming that Sterling's "trading entity," VFS, was to carry out the trading for the account of IPC participants. A month later, Slusser opened an account for Sterling at the Commerzbank in Dusseldorf, Germany, into which new IPC participants were directed to deposit their funds. VFS paid the subscription premium to IPC on behalf of participants who made deposits directly into the Sterling account. The remainder of the IPC money in the Sterling account was wired to bank accounts, commodity interest trading accounts and securities accounts held in the name of VFS.
VFS began trading a portion of the IPC pools' funds in late March 1989. VFS opened a commodity futures account at Goldenberg, Hehmeyer & Co. on March 31, 1989, with about $7.5 million of the IPC money. In mid-May 1989, the respondents opened their first of two trading accounts with Stotler and Company and their first of four trading accounts with Argus Corporation. On each of the account opening documents, the respondents indicated that no person or entity other than VFS had a financial interest in the account. At no time did VFS register with the Commission as a CPO or seek relief from registration, nor did Slusser register as an AP of VFS. Between February 14 and the end of April 1989, VFS's management of the IPC funds resulted in losses; the Goldenberg, Hehmeyer account, which was closed at the end of May, sustained losses of approximately $775,000. Although VFS sustained trading losses, between February 29 and May 31, 1989, VFS paid itself and related entities more than $1.2 million from the IPC funds.
Despite the fact that the IPC prospectus specified that the pooled funds were to be invested exclusively in financial futures, on May 25, 1989, VFS used IPC funds to open two securities trading accounts in its own name at Cantor, Fitzgerald. Although they never provided a power of attorney or written trading authorization, the respondents represented that the funds in the Cantor account represented "pooled money" which VFS was managing pursuant to various agreements.
Between March 7 and May 26, 1989, VFS retained an additional $1,039,499 from the IPC funds and transferred that amount into bank accounts in its name. In addition, VFS neither traded nor returned $180,615 that had been deposited by IPC into another VFS bank account.
Respondents' Activities Under the May Agreement
In late May 1989, Slusser learned that
German criminal authorities were investigating IPC and its officers for
financial irregularities and were questioning VFS's involvement with
IPC. At the end of May, Slusser traveled to Germany to meet with the
German authorities in the hope of convincing them that it was in the IPC
investors' best interests to give VFS total control of the pools.
Based on Slusser's representations that VFS's trading had been
profitable, that all the funds were invested, and that the investors
would suffer substantial losses if the invested funds were liquidated
prematurely, the German authorities, instead of liquidating the IPC
funds, permitted VFS to take complete control of the IPC commodity
pools.8 VFS and IPC executed an
agreement on May 31, 1989 (the "May Agreement"), pursuant to
which VFS assumed all of IPC's rights, obligations and duties with
respect to the commodity pool participants under the prospectus and
agreed to accept "sole responsibility . . . to protect, invest and
account for the assets transferred and assigned" under the
agreement. DOE Exhibit 51 at 1.9 VFS
further undertook to file "any and all reports required by governing
and regulatory authorities." Id. at 2.
Slusser was aware of the terms and conditions of the IPC prospectus no later than June 1, 1989.10 However, Slusser and VFS took no steps to conform their handling of the IPC funds to the IPC prospectus. The IPC Funds III and IV were not treated separately, nor did the respondents attempt to provide a mechanism to stop the trading of either fund when losses reached the levels prescribed in the prospectus. Moreover, on June 1, 1989 VFS, at Slusser's direction, created invoices to Eurocal for $1,299,000 in management services purportedly provided between February and May.11 The services described in the invoices had not been provided by VFS-which, in any event, was not entitled to fees or expenses under the February or May Agreements. During the first week of June, at VFS's request, IPC wired at least another $500,000 of investor money to VFS's checking account. This sum was never deposited into any trading account opened by VFS but instead was used by VFS for its own operations and for unrelated projects.
On June 14, 1989, several weeks after opening securities accounts in its own name at Cantor, VFS used IPC fund money to purchase FR Securities, an entity registered with the Securities and Exchange Commission and the National Association of Securities Dealers ("NASD") as a non-clearing broker-dealer, for the purpose of collecting commissions on securities trading in VFS's Cantor account. FR Securities had not introduced VFS to Cantor, did not have a clearing agrement with Cantor, and thus could not legitimately receive commissions from Cantor. Slusser asked Cantor to provide FR Securities with a backdated clearing agreement; Cantor declined. Slusser also falsified an account opening card to create the impression that FR Securities had introduced the accounts funded by the IPC money to Cantor on May 20, 1989-nearly three weeks before VFS purchased FR Securities. When advised by the former owner that FR Securities was not maintaining its books and records as required by the NASD, Slusser directed VFS staff to create a trading ledger and order tickets for FR Securities in order to create a false appearance of legitimacy.
The securities accounts at Cantor were closed on October 31, 1989 with losses of approximately $3,031,574. Despite the fact that Cantor cleared no trades for FR Securities and that FR Securities had not introduced the Cantor account, Cantor-at Slusser's direction-transferred approximately $947,499 in IPC funds to FR Securities for "accumulated fees."
On July 13, 1989, VFS purchased a registered IB using IPC money and changed the firm's name to FR Trading. VFS, which was FR Trading's only customer, then was treated as an introduced account at Stotler and Argus although FR Trading had not introduced the accounts. In this manner, from May through October 1989 FR Trading received more than $2 million in commissions from trading the IPC funds in the VFS accounts at Stotler and Argus.
The Respondents' Misrepresentations to IPC Investors and to German Authorities
On July 4, 1989, in apparent response to the German authorities' request that VFS return the IPC funds, Slusser advised the German criminal prosecutor investigating IPC that "many of the traded instruments will mature over the next 90 days. We project profits from these positions, but there will be substantial reductions in value if prematurely liquidated." DOE Ex. 66 at 2; Tr. at 396. Notwithstanding these representations, Slusser and VFS during this period continuously bought and sold futures contracts and securities on behalf of the IPC Funds in VFS accounts at Stotler, Argus and Cantor. On July 13, 1989 the German authorities issued an order to IPC to return all funds to the participants. Again, Slusser represented to the authorities that the IPC pools would suffer substantial losses if prematurely liquidated. DOE Ex. 66; Tr. at 396-97.
With Slusser's knowledge, VFS drafted a letter to the IPC participants in mid-July, advising them that Slusser was cooperating with the German authorities and that it was in the participants' interest to allow VFDS to hold the funds until September. In addition to misrepresenting their successful handling of the IPC funds and predicting that "100 percent of the fund monies" would be returned by the beginning of September, the July letter failed to advise the IPC participants that their funds were not being invested as represented in the prospectus. The letter also failed to disclose that the respondents were taking commissions although the prospectus entitled them only to a share of the profits, to inform the investors that their funds were being traded in securities when the prospectus specified that the funds were to be invested in financial futures, to inform investors that a portion of the funds was retained by the respondents and never invested, and to disclose that a portion of the investors' money was withheld by the respondents as payment for various fees not provided for in the prospectus.
Notwithstanding Slusser's representations to the German authorities and the IPC investors, VFS did not maintain any existing futures positions for 90 days after July 4, 1989. Rather, VFS traded the securities and commodity interest accounts aggressively, constantly putting on and taking off positions, and in the process generating $2.3 in commissions from FR Trading and about $950,000 in "accumulated fees" through FR Securities.
Liquidation of the IPC Funds
The liquidation of the IPC funds was effected by transferring the IPC money to a trust account in Germany for distribution to the IPC investors. The first transfer for liquidation was made on October 13, 1989, when $5 million was taken from the Cantor account to be transferred to the liquidation trust account. When the liquidation was completed at the end of November 1989, a total of $17,155,084 was taken by VFS from its trading accounts for transfer to the liquidation trust in Germany. However, only $16,633,546 was actually returned by VFS for distribution to the IPC investors. The remaining $521,538 was retained by the respondents to pay for "certain accumulated fees and administrative costs."
In the course of a three-day hearing in October 1997, the Division of Enforcement offered evidence that the missing funds were the result of fraud and misrepresentation by the respondents. The respondents essentially argued that the explanation can be found in a combination of trading losses and commissions and fees to which they were entitled. Slusser testified that the funds received by VFS pursuant to the February Agreement were not from IPC investors-or at least that he was not aware of the origins of the money. Tr. at 344, 355, 357, 359-60. The Division, through documentary evidence and witness testimony, established that the respondents knew that all the funds received by VFS came from IPC investors.
Slusser further stated that $5 million deposited into a VFS bank account on February 28, 1989 was treated as a "capital contribution" to VFS by IPC and Hieber and that, as such, the $5 million "belonged" to VFS. Tr. at 21. He also insisted that VFS was entitled to commissions and fees pursuant to agreements made subsequent to the February agreement, but conceded that he was unable to recall specifically any written agreements. Tr. at 335-36. With respect to the June 1, 1989 "invoices" created by VFS, Slusser acknowledged that those invoices were created while VFS was operating under an agreement that limited its income to a share of the profits. Tr. at 387-88.
The Initial Decision
In a lengthy decision, the ALJ found that the Division had established by a preponderance of the evidence that from at least May 26, 1989 through November 1989, the respondents had intentionally executed a "multi-faceted and complex" scheme to defraud the IPC pool participants of millions of dollars. Initial decision at 52. Accordingly, he found that VFS and Slusser committed commodity pool fraud in violation of sections 4o(1)(A) and (B) of the Act, that respondent FR Trading willfully aided and abetted Slusser's and VFS's violations of section 4o, and that Slusser and VFS cheated and defrauded customers in violation of section 4b of the Act. Purusant to section 13(b) of the Act, Slusser was found liable as a controlling person of VFS for its violations of the Act and Commission regulations. The ALJ's liability findings are supported by a detailed analysis of the record in light of the elements needed to prove a violation of sections 4b and 4o of the Act.
The ALJ further found that VFS acted as a CPO without being registered, in violation of section 4m(1) of the CEA; that VFS failed to operate its commodity pools in accordance with Commission regulations 4.20(a), (b) and (c); and that Slusser, without being registered, acted as an AP of VFS in violation of section 4k(2) of the Act. Moreover, the ALJ concluded that VFS violated Commission regulations 4.21(a) and 4.21(g) by soliciting, receiving and accepting funds from participants in commodity pools that it operated, without delivering to participants or filing with the Commission the disclosure documents required by the Commission.
The ALJ expressly discredited Slusser's testimony as "not believable. His statements are internally inconsistent, his assertions run contrary to the documentary evidence, and his demeanor gave rise to suspicion. Slusser was not forthright with his answers, and his attitude was one of smug irreproachability . . . his testimony on the whole is neither credible nor reliable." Initial decision at 12-13.
Turning to sanctions, the ALJ observed that the respondents' conduct "demonstrates their complete lack of appreciation for the Act and Regulations. They engaged in consistent and blatant violations of some of the most significant provisions of the law governing commodity futures transactions. Their wrongful behavior spanned nearly a year, and resulted in significant harm to the investors." Initial decision at 51. Based on his findings of fact and conclusions of law, the ALJ imposed substantial civil monetary penalties in addition to permanent trading prohibitions, registration revocations and cease and desist orders and offered a reasoned explanation for his choice of sanctions.
This appeal followed.
The respondents focus their appeal on alleged flaws in the ALJ's liability analysis and his choice of sanctions and urge the Commission to find that the ALJ erred in finding that the respondents committed fraud, that Slusser was liable as a controlling person of VFS, and that VFS was subject to the regulatory requirements imposed on CPOs. Moreover, the respondents argue that the claims against the respondents must be dismissed as barred by the statute of limitations. Finally, they challenge the civil penalties that were assessed as time-barred, excessive and inconsistent with Commission precedent.
Based upon our review, the record supports the ALJ's findings that the IPC funds were commodity pools, that VFS acted as a CPO, and that Slusser was a controlling person of VFS. The evidence also supports the ALJ's finding that the respondents violated the antifraud provisions of the Act by (1) circumventing the compensation provisions of the IPC prospectus to take funds from the IPC pools when there were no profits; (2) failing to use the participants' funds in the manner required by the IPC prospectus; and (3) failing to inform IPC participants that they were not adhering to the terms of the prospectus. The ALJ also properly concluded that VFS and Slusser were required to register with the Commission as a CPO and an AP of a CPO,12 respectively, and that VFS violated Commission regulations by, among other things, commingling money from Funds III and IV and with funds in VFS's corporate bank and trading accounts.
I. The Violative Conduct
A. VFS's Failure to Register as a CPO Under Section 4m of the Act
The respondents have not challenged the ALJ's finding that IPC Funds III and IV were commodity pools. They maintain, however, that VFS was not required to register as a CPO under Section 4m(1) of the Act and was not subject to the requirements of the Act of Commission regulations because the IPC pools consisted entirely of foreign funds solicited outside the United States.
A CPO is defined as any person who solicits, accepts or receives from others funds, securities or property for the purpose of trading in a commodity pool. 7 U.S.C. § 1a(14). Section 4m of the Act, 7 U.S.C. § 6m, requires that all persons performing the functions of a CPO register with the Commission unless they are subject to an exemption from registration. VFS clearly was operating as a CPO. It accepted investment funds from IPC and from individual investors who deposited funds in VFS's Sterling Bank account for the purpose of trading in a commodity pool. Accordingly, VFS was required to register as a CPO.
The respondents' reliance on a series of Commission interpretative letters providing relief from registration is misplaced for several reasons. First, in the letters cited by respondents the Division of Trading and Markets ("T&M") has provided relief from CPO registration where the CPO is (1) located outside the United States; (2) confines its commodity pool activities to areas outside the United States; (3) does not allow participation in the commodity pool by any resident or citizen of the United States; and (4) does not obtain, as commodity pool contributions, any funds or other capital contributions from U.S. sources. See CFTC Interpretative Letter No. 76-21, [1975-76 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 20,222 (Aug. 15, 1976). None of the interpretative letters relied on by the respondents suggests that VFS could have avoided either the CPO registration requirements or the antifraud provisions of the Act merely by limiting pool participants to non-U.S. residents. Six of the seven letters cited by the respondents provided exemptive relief to CPOs or commodity trading advisers ("CTAs") that were already registered with the Commission or with the SEC.13 The remaining letter involved a request for exemptive relief by the sole general partner of an investment fund that had four limited partners, each of whom was a "qualified eligible participant" under Commission regulation 4.7. The grant of relief did not turn on the question of foreign pool participants.14
Moreover, even if the letters cited by the respondents were analogous, interpretative letters express the opinion of T&M staff and do not carry the force of law. In re Antonacci, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,835 at 36,932 (CFTC April 18, 1990). These letters are written to specific parties based on specific facts and circumstances; they have no general applicability, nor do they bind either the Commission or third parties.
Finally, while there are exceptions to and exemptions from CPO registration and related requirements, to obtain such relief a CPO must file a written claim of exemption. CFTC Advisory No. 18-96, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,659 at 43,749 (CFTC April 11, 1996). The respondents in the instant case neither registered VFS as a CPO nor filed a claim for an exemption from registration; moreover, they do not now claim that an exemption is applicable to VFS's activities. Accordingly, VFS remained subject to the registration, reporting, recordkeeping and antifraud provisions of the Act, and the ALJ properly found the VFS violated Section 4m(1) of the Act by failing to register with the Commission as a CPO.
The respondents have not challenged the ALJ's finding that VFS violated Commission regulations 4.20(a), (b) and (c) and 4.21(g). By commingling funds from Funds III and IV and depositing the funds in bank and trading accounts held in VFS's name, VFS clearly violated regulation 4.20(a) (requiring CPOs to operate its pools as legal entities separate from the CPO); 4.20(b) (requiring that funds received by a CPO from a pool participant be received in the pool's name); and 4.20(c) (prohibiting the CPO from commingling pool funds). In addition, VFS failed to file required disclosure documents with the Commission for each pool it operated, in violation of regulation 4.21(g).
B. The 4b Violations
Section 4b, the broad antifraud provision of the act, generally prohibits deceitful conduct related to futures trading. Section 4b(a)(i) makes it a violation of the Act for any person to cheat or defraud any other person in connection with the making of a commodity futures contract. While the elements needed to prove a violation of section 4b are derived from those used to establish fraud at common law, they are not identical. Puckett v. Rufenacht, Bromagen & Hertz, Inc., 903 F.2d 1014, 1018 (5th Cir. 1990).15 To prevail on a charge of 4b fraud in an administrative enforcement action, the Division must prove only that the respondents made, in connection with commodities transactions, material misrepresentations or omissions of fact, and that they did so with scienter. The Division is not required to establish reliance or actual damages. In re Staryk, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,206 at 45,810 (CFTC Dec.18, 1997); In re JCC, Inc., [1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,080 at 41,574 n.17 (CFTC May 12, 1994); In re GNP Commodities, Inc., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,360 at 39,218 (CFTC Aug. 11, 1992), aff'd in part and modified sub nom. Monieson v. CFTC, 996 F.2d 852 (7th Cir. 1993).16
Failing to recognize this critical distinction, the respondents assert that the Division should have been required to prove that "specific German investors were solicited by and relied on the terms of the IPC prospectuses for Funds III and IV and that Respondents received monies from these Funds from identified investors." Resp. Br. at 26. This argument is without legal support, and the respondents' reliance on the American Metals decision is misplaced. The Commission has rejected the American Metals analysis that reliance is an essential element of 4b fraud, and has held consistently that in an enforcement action, the elements of 4b fraud do not include either investor reliance or actual damages.17 In an enforcement case, the focus is whether the broker made misrepresentations or failed to disclose material information. In re JCC, Inc., ¶ 26,080 at 41,547 n.17; In re Staryk, ¶ 27,206 at 45,810; In re Ferragamo, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,982 at 37,598 n.16 (Jan. 14, 1991).
(a) "In Connection With"
The respondents argue on appeal that the "in connection with" requirement of section 4b can be satisfied only where investors have been caused to "sell or liquidate their interests in IPC funds." Resp. Br. at 28-29. This narrow interpretation of section 4b was properly rejected by the ALJ as unsupported by applicable case law. The Commission specifically has rejected the argument that section 4b does not reach losses caused by fraud unless the losses arose from the actual purchase or sale of a futures contract. Secrest v. Madda Trading Co., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,627 at 36,699 n.15 (CFTC Sept. 14, 1989); cf. In re R&W Technical Services, Ltd., et al., CFTC Docket No. 96-3, 1999 WL 152619 at *22 (CFTC March 16, 1999). In evaluating the "in connection with" language of section 4b(a), courts of appeals have observed that the legislative history of the Act "indicates a progressive trend toward broader application of the CEA." Saxe v. E.F. Hutton & Co., Inc., 789 F.2d 105, 111 (2d Cir. 1986) (misrepresentations concerning the profitability of a CTA constitute a violation of 4b); Hirk v. Agri-research Council, Inc., 561 F.2d 96, 103-04 (7th Cir. 1997). In Hirk, the Seventh Circuit found that the legislative history of the CEA, and the treatment by the Supreme Court of similar language in the Securities Exchange Act of 1934 and SEC Rule 10b-5, cannot justify a "narrow interpretation of the broad `in connection with' phrase." Hirk, 561 F.2d at 104. See also Saxe, 789 F.2d at 110-111.
The ALJ properly concluded that the respondents' conduct satisfies the "in connection with" requirement. The record established that the respondents knowingly took control of the commodity pools and traded millions of dollars of investors' money in the futures markets. Many of the respondents material misstatements and omissions of fact were "inseparably linked to their gaining control of the funds, receiving deposits directly from investors into the funds, and profiting from the trading of the funds." Initial decision at 33.
(b) Material Misrepresentations or Omissions of Fact
The respondents essentially claim that they had no duty to the IPC investors because under the May Agreement they undertook only to provide services to IPC, which in turn retained control of the funds and a fiduciary duty to the investors. The May Agreement makes clear that VFS took complete control of the funds as of May 31, 1989 and asumed all responsibilities and duties to the IPC investors from that date forward. The ALJ correctly concluded that most of the information withheld from the investors is required to be disclosed by Commission regulations and is per se material, and that much of the remaining withheld information fits squarely within Commission case law defining materiality.18
The respondents are correct that they were not bound by the prospectus; they cannot be-and have not been-held liable for misrepresentations and omissions made by IPC in the prospectus. After gaining control of the funds, the respondents were free to handle the funds as they saw fit consistent with the requirements of the Act and Commission regulations. Their decision to deviate materially from the prospectus, however, required substantial disclosures to the IPC investors. In re Commodities International Corp., [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,943 at 44,563-64 (CFTC Jan. 14, 1997); In re Kolter, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,262 at 42,199 (CFTC Nov. 8, 1994).
These disclosures were never made. Specifically, although the prospectus limited compensation to a percentage of the profits, the respondents in the absense of profits took more than $3 million in commissions and fees with no disclosure to the IPC investors. The Commission previously has held that the failure to disclose a commission arrangement is material. See, e.g., In re Citadel Trading Corp., ¶ 23,082 at 32,187; In re Rosenthal & Co., [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,221 at 29,177 (CFTC June 6, 1984). Before the Commission, the respondents contend that there was no failure to disclose VFS's plan to take commissions because Slusser claimed to have disclosed this plan to IPC officers and others. Resp. Br. at 24-25. Even if the Commission were to ignore the ALJ's demeanor-based credibility findings as to Slusser, the respondents' fiduciary duty was to the pool participants-not, as they claim, to the IPC officers, the German authorities, or the independent auditors. See, e.g., In re Commodities International Corp., ¶ 26,943 at 44,563; In re Armstrong, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,332 at 42,611 (CFTC March 10, 1995); Weinberg v. NFA, CFTC Docket No. CRAA-86-1, 1986 WL 66170 at *7 (CFTC June 6, 1986).
In its July 1989 letter to IPC investors, VFS made several material misrepresentations and omissions.19 These misrepresentations include VFS's statement that the May Agreement created no legal relationship between VFS and the IPC participants, and the representation that VFS was subject to oversight by NFA and the SEC. The latter statement, while literally true, invites the inference that VFS actually was registered with NFA and the SEC while it was handling investor funds. This was not the case. Because VFS failed to register as a CPO, it was subject to no regulatory oversight whatever.
VFS also represented that it had handled the IPC funds successfully and expressed optimism that all the funds would be returned to investors by September 1989. The respondents attempt to defend this statement by arguing that it was not misleading because it was "made in the context of Cantor's misreporting of the balance" in VFS's securities trading account." Resp. Br. at 24. Regardless of errors by Cantor in calculating the balance in VFS's account, the respondents' claimed reliance on Cantor's statements is not a defense to fraud. A commodity professional cannot discharge his or her fiduciary duty to investors by the "uncritical repetition" of information. Dill v. Sutton Ross Assoc., Inc., CFTC Docket No. R81-1114-82-77, 1985 WL 55290 at *1 (CFTC Aug. 22, 1985).20 As the ALJ observed, the respondents' representation of its successful past and future management of the pool funds was "simply false, as the accounts had lost millions of the investors' dollars." Initial decision at 37.
Finally, the respondents advance the argument that no German investor or IPC official has ever made a claim against them. Resp. Br. at 25. This fact is neither probative nor surprising. The May Agreement included an agreement between VFS and IPC "not to institute any legal proceedings against the other for whatever cause." The IPC investors' liquidation agreements included a release in which the investor "validly and bindingly declares that upon payment . . . he or she will relinquish any claim against VFS and its representatives."
(c) Fraudulent Misappropriations of Pool Funds
As the ALJ observed, the respondents "did not limit their fraud to taking commissions and fees to which they were not entitled. They also surreptitiously retained money in their own bank accounts that should have been traded on behalf of the IPC investors . . . or returned to them at liquidation." Initial decision at 38. Misappropriation of commodity pool funds constitutes fraud in connection with commodity transactions under Section 4b of the Act.21 CFTC v. Morse, 762 F.2d 60 (8th Cir. 1985); CFTC v. Skorupskas, 605 F. Supp. 923, 932-33 (E.D. Mich. 1985).
The record reflects that, beginning on June 1, 1989-the day after the May Agreement was signed-the respondents drew up false invoices for various fees and expenses incurred by VFS in managing the IPC pools between February and May 1989. These fees, which were not permitted by the February Agreement or by the IPC prospectus, had not been disclsoed by VFS nor approved by IPC or Eurocal. Although the invoices were directed to Eurocal, they were never submitted; the respondents simply took the money from the IPC funds. In this manner, the respondents misappropriated more than $1 million of the investors' funds. Slusser conceded at the hearing that at the time the invoices were created, VFS was operating under an agreement that limited its income to a share of the profits. Tr. at 387-88. The respondents retained an additional $1.5 million of IPC investor money "without even creating the pretext that they had earned it." Initial decision at 38.
A finding of fraud under section 4b requires proof that the respondents made material misrepresentations and omissions with scienter. Scienter is established by showing that the respondents' acts were committed intentionally or with reckless disregard for their duties under the Act. Hammond v. Smith Barney, Harris Upham and Co., Inc., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,617 at 36,659 (CFTC Mar. 1, 1990); In re ContiCommodity Services, Inc., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,038 at 37,878-79 (CFTC April 17, 1991). As the ALJ observed, a finding of scienter can be based on inferences drawn from circumstantial evidence. Initial decision at 39, citing In re JCC, Inc., [1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,080 at 41,579 (CFTC May 12, 1994). While the ALJ noted that "all of Respondents' actions in handling the IPC funds indicate that they were taken with the sole intention of generating as much income to Respondents as possible, for as long as they could get away with it," he focused particularly on the respondents' orchestration of the payment of unauthorized and unearned commissions to FR Trading and FR Securities, and on their creation of false invoices and other misappropriations of IPC investor funds.
The record reflects that Slusser and VFS used FR Trading and FR Securities as conduits through which VFS collected unearned commissions from its trading for the IPC commodity pools. FR Trading, an IB, was purchased by VFS on July 13, 1989. Through the respondents' efforts, however, it was paid commissions on trading that occurred months before it had any association with VFS or with the IPC funds.22 During the period from May through July 13, 1989, when FR Trading had no relationship with VFS and did no trading for the IPC accounts, it collected approximately $480,000 in commissions for trading done in the VFS accounts.23 Despite the fact the FR Trading did not introduce VFS's accounts, it received from Argus and Stotler approximately $2.3 million in commissions for VFS's futures trading between May and October 1989.
In late May 1989, VFS opened securities accounts in its own name at Cantor and deposited IPC funds into those accounts. Just as they had done with the futures trading accounts, VFS and Slusser then set up a subsidiary, FR Securities, to collect commissions on its securities trading for the IPC investors. Leaving aside the obvious fact that VFS was not authorized under the IPC prospectus or the February and May Agreements to trade securities, the manner in which the commissions were taken from the Cantor account indicates that the respondents acted with the intent to misappropriate these funds. FR Securities did not introduce the account and had no clearing agreement with Cantor-in short, there was no legitimate mechanism by which FR Securities could be compensated for the IPC trading. In an attempt to cure these problems, Slusser asked Cantor to backdate a clearing agreement to legitimize the compensation, and he falsified an account opening card to create the impression that FR Securities had introduced the accounts to Cantor on May 20,1989-nearly three weeks before VFS purchased FR Securities. DOE Ex. 21, 29; Tr. at 93-94, 271-72. Slusser also attempted to remedy FR Securities' NASD recordkeeping problems by directing VFS staff to create, after the fact, a trading ledger and order tickets to give FR Securities the appearance of legitimacy. DOE Ex. 21; Tr. at 129-30.
Although Cantor cleared no trades for FR Securities, at the end of June Slusser directed Cantor to wire approximately $300,000 in "accumulated fees" for trading from May through June to FR Securities' bank account. On three other occasions between June 27 and September 22, 1989, Cantor-at Slusser's direction-transferred more than $900,000 of IPC money from the VFS securities accounts to FR Securities. DOE Ex. 33, 94; Tr. at 280-82. The respondents persist in asserting that these funds were properly appropriated by them as commissions to FR Securities.
None of respondents' actions can be characterized as the result of negligence or inadvertence. The respondents nonetheless claim that they cannot have acted with the requisite scienter because they were unaware of the IPC prospectus and did not realize that investor funds were involved. Resp. Br. at 30-34, citing Wasnick v. Refco, 911 F.2d 345, 348 (9th Cir. 1990) (mere mistake, negligence or inadvertence fails to meet section 4b's scienter requirement); and Drexel Burnham Lambert v. CFTC, 850 F.2d 742, 748 (D.C. Cir. 1988). Their argument strains credulity. Even if the respondents were unaware of the prospectus while they were operating under the February Agreement, documentary and testimonial evidence established that Slusser and VFS were aware by late February that the funds VFS received from Eurocal/IPC were to be traded for the account of IPC investors. Nor can the respondents claim ignorance of the terms of the February Agreement, which restricted their compensation to a percentage of the trading profits and limited their trading to financial futures. In blatant disregard of the agreement, the respondents opened securities accounts at Cantor in May 1989, and created false invoices for "fees and expenses" incurred in managing the IPC pools from February through May 1989.
In any event, the bulk of the respondents' violative conduct occurred subsequent to the May Agreement. The record establishes that Slusser was aware of the major terms of the IPC Prospectus relating to Funds III and IV no later than June 1, 1989-one day after the agreement was executed. Slusser's handwritten notes dated June 1, 1989 recite the compensation arrangements for managing the funds. Slusser received a copy of the prospectus during June, and a VFS employee testified that the prospectus was available and on display at VFS headquarters. Tr. at 116-19. The respondents concede that they "eventually" became aware of the terms and conditions of the IPC prospectus, but they urge that it is "imperative" to remember that
Slusser and VFS essentially found themselves holding a pot of money, from undetermined sources, the nature and source of which could not be unraveled . . . . But even in the face of this, the Respondents attempted to make the best of it.
Resp. Br. at 32.24 We agree with the ALJ that this argument
is preposterous. Even assuming that the respondents were confused as to
the terms of the prospectus and the identity of the investors prior to
May 31, the respondents may not "rely on confusion and
misinformation to avoid liability" under section 4b. Hammond,
¶ 24,617 at 36,659. Moreover, the respondents concede that Slusser
knew that his companies held IPC funds no later than the end of May 1989.
Resp. Br. at 32. The respondents' creation of false invoices, the
bulk of their misappropriation of commissions and other unauthorized
fees, and their failure to trade or return a portion of the
investors' funds-all unlikely to have been unintentional
acts-occurred after that time. At a minimum, the respondents acted with
reckless disregard for their duties under the Act. Id; Drexel, 850
F.2d at 748.
C. Section 4o Violations
The analysis for determining a violation of Section 4o is essentially the same as that for establishing a violation of section 4b, with two notable distinctions.25 Section 4o contains no explicit "in connection with" requirement and, with respect to section 4o(1)(B), there is no scienter requirement. Thus, under this section, "[i]f the trading advisor or commodity pool operator intended to do what was done and its consequence is to defraud the client or prospective client, that is enough to constitute a violation of section 4o." CFTC v. Savage, 611 F.2d 270, 285 (9th Cir. 1980); In re Kolter, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,262 at 42,198 (CFTC Nov. 16, 1994). Where the record establishes that the respondents engaged in fraudulent conduct in violation of section 4b the Division has, as the ALJ observed, surpassed its burden of proof with respect to section 4o.26
The Commission specifically has found that failure to disclose a commission arrangement and failure to invest pool funds in a manner consistent with written representations to the pool participants violates section 4o. In re Armstrong, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,332 at 42,611 (CFTC March 10, 1995); In re Stotler and Co., [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,298 at 32,814 (CFTC Sept. 30, 1986). Here, the IPC prospectus stated that the pool operator would be compensated by a share of the profits from investing particpants' funds. Despite the respondents' claimed ignorance of the terms of the prospectus, the record supports the ALJ's finding that Slusser was aware of the relevant terms by June 1, 1989. This awareness is reflected in Slusser's dated and handwritten notes reciting the relevant compensation provisions. The respondents themselves acknowledge that Slusser became aware that his companies were holding IPC funds by late May 1989 when he traveled to Germany. Resp. Br. at 32. The respondents' misappropriation of commissions and fees occurred primarily after June 1, 1989. Moroever, on that date the respondents assumed all obligations to the IPC investors, including the obligation to disclose their compensation arrangements to the IPC participants. Their failure to do so violates both 4b and 4o of the Act.
The record also supports the conclusion that the respondents failed to invest the pool funds in the manner described in the prospectus. The prospectus stated that IPC Funds III and IV would be invested in futures and options on futures.27 Notwithstanding this clear limitation, the respondents opened securities accounts at Cantor, where they lost millions of fund dollars trading securities. Failure of a CPO to inform pool participants that funds will be invested in a manner contrary to that designated in the disclosure documents is a scheme that operates as a fraud on pool participants in violation of section 4o(1)(B). In re Kolter, ¶ 26,262 at 42,194-95.
D. Slusser's Liability Under Section 13(b) of the CEA
A person who controls any person who has violated the Act may be held liable under section 13(b) "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 a violation" of the Act. In re Guttman, CFTC Docket No. 93-4, 1998 WL 205134 at *16 (CFTC April 27, 1998). The fundamental purpose of section 13(b) is to allow the Commission to reach behind the business entity to its controlling individual. In re Apache Trading Corp., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,251 at 38,794 (CFTC March 11, 1992). "Determination of whether a person is a controlling person is fact specific and requires a thorough examination of all the circumstances." Guttman, 1998 WL 205134 at *16.
The respondents argue that Slusser was not a controlling person because, while he had general control over VFS, he did not direct all of its activities. Resp. Br. at 39. The Commission has emphasized that the failure to exercise the authority to direct the management or policies of a person or entity does not establish the absense of control.28 Spiegel, ¶ 24,103 at 34,765 n.4; Guttman, 1998 WL 205134 at *16; Monieson, 996 F.2d at 859. Slusser was sole owner, treasurer and chairman of the board of VFS, "ran the organization," and "had the ultimate say-so." Tr. at140-141. He negotiated and entered into contracts on behalf of VFS, personallly signed both the February and May Agreements, and was the signatory authority on most, if not all, of the bank and trading accounts of VFS and its subsidiary. Slusser directed VFS's purchase of FR Trading and FR Securities. He asked Cantor to backdate a clearing agreement with VFS and to transfer funds from the VFS trading account to VFS's personal account as "accumulated fees." Tr. at 271, 311-314.
The Commission consistently has found controlling person liability in similar circumstances. See In re GNP Commodities, Inc., ¶ 25,360 at 39,216; aff'd in part sub nom. Monieson v. CFTC, 996 F.2d 852 (7th Cir. 1993); Spiegel, ¶ 24,103 at 34,765 n.4. Applying Commission case law to the instant circumstances, Slusser is the textbook controlling person and, as such, is liable for VFS's violations of sections 4o and 4m(1) of the Act and Commission regulations 4.20(a), (b) and (c), 4.21(a) and 4.21(g).
The respondents raise several challenges to the ALJ's choice of sanctions, arguing that (1) the ALJ failed to consider Slusser's net worth in determining the amount of the civil penalty; (2) the civil penalty imposed is inconsistent with the penalties imposed in similar cases; and (3) the Division was time-barred from seeking civil monetary penalties for conduct that occurred more than five years before the complaint was filed.
1. Net Worth Issues
Because the respondents' violative conduct occurred in 1989, the ALJ applied the standards of former section 6(d) of the Act to determine the amount of the civil monetary penalty. In re Gordon, [1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,921 at 40,181 (CFTC March 16, 1993). Those standards require consideration of both the gravity of the violations and the respondents' net worth. In re Grossfeld, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,921 at 44,464 n.17 (CFTC Dec. 10, 1996).
The respondents contend that the ALJ erred in holding that their failure to submit evidence relating to net worth constituted a waiver of the opportunity to do so. In their attempt to shift the blame for their failure to address their net worth, they argue that the Division had a duty to produce evidence of their net worth at the hearing. There is no merit to this contention, and no support for their position in the Commission decisions on which they rely: In re Rothlin, [1982-1984 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 21,851 at 27,572 (CFTC Dec. 24, 1981); andGrossfeld, ¶ 26,921 at 44,464 n.17. Both Rothlin and Grossfeld hold that the burden of producing evidence of net worth lies with the respondent, because he generally controls the information probative of his own financial condition.
The CEA specifically provides the range of sanctions for the respondents' violations. Moreover, the administrative complaint provided explicit notice that the relief sought could include "a civil penalty not to exceed $100,000 for each violation of the Act and Regulations."29
Complaint at 29. "Once a respondent is notified that his net worth is likely to be a material issue in an enforcement proceeding, he must demonstrate why the contemplated civil penalty is excessive in light of his financial circumstances." Grossfeld, ¶ 26,291 at 44,466, citing In re Murlas Commodities, Inc., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,440 at 35,930 (CFTC April 24, 1989). Where, as here, the respondents failed to submit evidence relating to net worth, or to request a net worth hearing at any time during the proceedings, the ALJ did not err in finding that they waived the opportunity to do so. In re Rousso, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,133 at 45,311 (CFTC July 30, 1997), aff'd Rousso, et al. v. CFTC, No. 97-4232 (2d Cir. March 11, 1998).
The respondents also challenge the ALJ's failure to consider the collectability of civil penalties. Resp. Br. at 41-42. Neither the Debt Collection Act of 1982, Pub. L. No. 97-365, 96 Stat. 1749, nor the Federal Claims Collection Standards, 4 C.F.R. §§ 101-105 (1984) ("FCCS"), mandate that a government agency consider ability to pay when assessing a civil penalty. The FCCS considers such an inquiry relevant only in determining whether an agency may compromise an existing claim. 4 C.F.R. § 103.2. The Commission has concluded that "a finding that the civil monetary penalty would not be collectable does not preclude its imposition." In re Incomco Inc., [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,901 at 34,205 n.7 (CFTC July 16, 1987). Moreover, because the respondents failed to introduce evidence of net worth showing that a civil penalty would be uncollectable, and because the record evidence established that the respondents reaped enormous profits from their fraudulent scheme, the ALJ did not err in failing to address collectability.
2. The Appropriateness of the Civil Penalty
(a) The Relevant Factors
The CEA prohibits the conduct for which the respondents were found liable and sets forth the available sanctions for each violation of the Act. 7 U.S.C. § 9. Section 6(e)(1) of the Act, 7 U.S.C. § 9a(1), states that in determining the amount of a civil monetary penalty, the Commission shall consider the appropriateness of the penalty to the gravity of the violation. The ALJ, citing the gravity of the respondents' violations, the financial benefit that accrued to them and the losses suffered by the IPC participants as a result of the respondents' wrongdoing, imposed on Slusser, VFS and FR Trading a civil penalty of $10 million for which they are jointly and severally liable. The ALJ explained that "[t]his figure represents all of the ill-gotten gains of Respondents, adding at least a portion of the trading losses suffered by the investors as a `premium to offset the benefit of engaging in the intentional, egregious conduct at issue here. This amount rationally reflects the purposes underlying the use of the civil money sanction, and is within the acceptable range supported by the record." Initial decision at 54, citing In re GNP Commodities, ¶ 25,360 at 39,222. The respondents essentially contend on appeal that the penalty assessed by the ALJ is excessive and is not based on appropriate consideration of prior sanctions imposed by the Commission.30
The Commission reviews sanctions de novo, focusing on the appropriate sanction in light of the facts and circumstances rather than on the quality of the assessment made by the ALJ. Grossfeld, ¶ 26,921 at 44,467. In recent decisions, the Commission has explained that in determining the measure of sanctions commensurate with the gravity of the misconduct, it will focus on the following factors: the relationship of the violation to the regulatory purposes of the act; the respondent's state of mind; the consequences flowing from the violative conduct; and the respondent's post-violation conduct. The Commission also may consider any mitigating or aggravating circumstances presented by the facts. Rousso, ¶ 27,133 at 45,310; Grossfeld, ¶ 26,921 at 44,467-68. The Commission also has indicated that where a violation involves customer fraud, it will consider in assessing penalties the financial benefit to the respondent or the loss suffered by customers, and will impose civil monetary penalties designed to deprive the respondents of their ill-gotten gains. In re Gordon, ¶ 25,667 at 40,182; cf. In re Reddy, 1998 WL 44574 (CFTC Feb. 4, 1998). Where the losses or gains in a customer fraud case are substantial, so have been the civil penalties. After due consideration of the relevant factors, we have concluded that the civil monetary penalty imposed by the ALJ is appropriate to the respondents' violative conduct.
Customer fraud is a violation of the core provisions of the Act. Such conduct historically has been considered to be "among the most serious of violations for purposes of initially determining the severity of the sanctions to be imposed under the Act" and consistently has warranted substantial civil penalties. Grossfeld, ¶ 26,921 at 44,468; see also In re Ferragamo, [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,795 at 34,104 (ALJ Aug. 14, 1987). The respondents' continuous violations of the antifraud provisions of the Act warrant significant sanctions. Similarly, the intentional and willful nature of their conduct bears on an assessment of gravity. Severe sanctions are warranted where a respondent "knowingly and repeatedly violates the same statutory provision. . . . :" Grossfeld, ¶ 26,921 at 44,467 n.29; In re Premex, [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,165 at 34,891 (CFTC Feb. 17, 1988); In re Flynn, [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,271 at 35,202 (CFTC June 20, 1988).
In cases involving customer fraud, the adverse consequences flowing from the violative conduct may encompass the financial benefit to the respondent and the loss to customers resulting from the wrongdoing. In re Miller, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,440 at 42,912 (CFTC June 16, 1995); Commodities International Corp., ¶ 26,943 at 44,566-67; Grossfeld, ¶ 26,921 at 44,468. Section 6(c) of the Act permits an assessment of up to $100,000, or triple the monetary gain to the respondent, for each violation. In a customer fraud case such as this, where the misrepresentations are not readily quantifiable, the Commission's assessment of civil monetary penalties properly begins with a calculation of the gain to the respondents.31 The respondents realized approximately $6 million as a result of their violative conduct; this figure provides an appropriate "floor" for the civil penalty.
While the losses to IPC investors are difficult to quantify, the net loss of $6.5 to the pools is an adverse consequence of the respondents' wrongdoing that adds to the gravity of their violations. Moreover, approximately $3 million of the $6.5 net losses suffered by the IPC funds is attributable to the respondents' trading in securities in contravention of the prospectus. Initial decision at 19, 25.
A respondents' post-violation conduct-including efforts to cooperate with authorities, to cure the violations, or to make restitution-also bears on an assessment of sanctions. Rousso, ¶ 24,165 at 34,981; Grossfeld, ¶ 26,921 at 44,468 n.31; Premex, ¶ 24,165 at 34,891. These respondents made no attempt to cure their violations or to cooperate with the Commission by providing credible testimony. The ALJ specifically discredited Slusser's testimony as inconsistent, self-serving and evasive. Moreover, the respondents persist in their assertion that they did nothing wrong and that their only motive was to help the IPC investors. Overall, the respondents' post-violative conduct adds to the gravity of their violations.
In light of all of these factors, the imposition of $10 million in civil monetary penalties is well within the Commission's discretion.
(b) Consistency with Sanctions in Prior Cases
On appeal, the respondents claim that the ALJ erred in imposing penalties without considering the level of sanctions imposed in the past for similar violations. Resp. Br. at 42, citing In re Siegel Trading Co., [1977-1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 20,452 at 21,847 (CFTC July 26, 1977). The Commission consistently has imposed substantial civil penalties in cases involving customer fraud. Moreover, even if the civil penalties assessed in prior Commission decisions were less stringent, the respondents' challenge must fail.32 Courts have uniformly rejected the notion that uniform sanctions must be imposed by an administrative agency for similar violations. See Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 198 (1973); FTC v. Universal-Rundle Corp., 387 U.S. 244, 250-51 (1967). An agency's choice of the appropriate sanctions may be reversed only if it is unwarranted in law or unjustified in fact. Butz, 411 U.S. at 185-86; Monieson v. CFTC, 996 F.2d at 858.
It is well-settled that the choice of a sanction within the Commission's authority is not rendered invalid because it is more severe than sanctions imposed in other cases. See FCC v. WOKO, 329 U.S. 223, 227-28 (1946); Butz, 411 U.S. at 187; Universal-Rundle, 387 U.S. at 250-51. In this regard, the Commission has clearly articulated its view that in choosing sanctions within the range provided by congress it is not bound by the sanctions chosen in earlier cases:
[E]ffective deterrence can be undermined by an undue focus on the levels of civil
monetary penalties that we have imposed in prior cases. Indeed, in our experience,
it is rare that we find cases to be truly analogous on the factors material to the selection
of an appropriate civil money penalty.
Grossfeld, ¶ 26,921 at 44,468.33 Thus, the argument that the penalty imposed on these respondents appears more substantial than those imposed in prior cases is insufficient as a matter of law and Commission policy to warrant modification.
(c) Statute of Limitations
The ALJ properly rejected the respondents' claim that "the Division is time-barred from seeking the imposition of civil monetary sanctions based on the alleged violative conduct, which occurred more than five years before May 24, 1994, the day its Complaint was filed." Resp. Br. at 37, citing 28 U.S.C. § 2462. Section 2462 of the Judicial Code provides for a general five-year statute of limitations for an action to enforce a civil fine, penalty or forfeiture. Even if Section 2462 is a valid defense to an administrative action seeking civil penalties, the respondents' argument would lack merit. The respondents' primary violations occurred after May 31, 1989 when they took control of the IPC funds pursuant to the May Agreement. This misconduct falls squarely within the five-year period.
Where the default statute of limitations applies, an action can be brought for violations occurring within five years of filing the complaint even if the violations began more than five years prior to suit. U.S. v. Marine Shale Processors, 81 F.3d 1329 (5th Cir. 1996). As the ALJ correctly found, the respondents' violations were continuing in nature and, accordingly, "a new claim accrues each day the violation is extant." Initial decision at 53, n.40, citing Interamericas Investments, Ltd. v. Board of Governors of the Federal Reserve System, 111 F.3d 376, 382 (5th Cir. 1997). While the Interamericas decision relied in part on a specific provision for continuing violations in the Bank Holding Company Act, the Court of Appeals first considered whether Section 2462 permits application of a continuing violation theory and concluded that continuing violations are indeed cognizable under Section 2462. The court observed that a continuing violation generally exists where the conduct is ongoing rather than a single event. Id. at 382; Toussie v. United States, 397 U.S. 112, 136 (1970). Under the Interamericas analysis, the ongoing nature of the respondents' violative conduct brings their actions squarely within the scope of the Commission's authority, and civil sanctions are not foreclosed by Section 2462.34
In light of the foregoing, the ALJ's initial decision is affirmed in all respects. The trading prohibitions, registration revocations and civil monetary penalties shall become effective 30 days from the date this order is served.35
IT IS SO ORDERED.
By the Commission (Acting Chairman SPEARS and Commissioners HOLUM and NEWSOME). (Commissioner ERICKSON, not participating).
Jean A. Webb
Secretary of the Commission
Commodity Futures Trading Commission
Dated: July 19, 1999
complaint charged that respondents Slusser, First Republic Financial
Corporation (formerly known and referred to herein as Vancorp Financial
Services, or "VFS") violated the antifraud provisions of
sections 4b(a)(i), 4o(1)(A) and 4o(1)(B) of the Act. VFS was charged with
violating section 4m(1) of the Act by failing to register as a commodity
pool operator ("CPO") and with violating Commission regulations
4.20(a), (b) and (c) and 4.21(a) and (g) by improperly operating a
commodity pool. Slusser was charged with failing to register as an
associated person ("AP") of VFS in violation of section 4k(2)
of the Act and was charged under section 13(b) with liability as a
controlling person for all of VFS's violations. Finally, FR Trading
was charged under section 13(a) of the act with aiding and abetting
Slusser's and VFS's violation of Section 4o of the Act.
2 The Commission reached settlements with respondents Edward Hamlet and Cantor Fitzgerald & Company. See In re Slusser, CFTC Docket No. 94-14, Order Making Findings and Imposing Remedial Sanctions as to Respondent Edward T. Hamlet (CFTC October 28, 1997) and Order Making Findings and Imposing Remedial Sanctions as to Respondent Cantor Fitzgerald & Company (CFTC January 28, 1997). In his August 24, 1998 initial decision, the ALJ granted the Division's motion for a default judgment against respondent Hans Brinks.
3 Slusser was also an eighty percent shareholder of the Sterling National Bank, Ltd., an offshore bank whose license was revoked on April 4, 1989 by the government of the Island of Montserrat. Sterling did no business and existed solely as a post office drop.
4 Rainer Hieber, one of the IPC directors, had unlimited authority to sign all documents related to the business of IPC.
5 The February Agreement acknowledged that the funds were held "in custodianship" under an arrangement between Eurocal and IPC. Supplemental correspondence between VFS and Hieber also reflects that the funds were to be traded by VFS for the account of IPC Fund participants. Tr. 438-39.
6 The February Agreement itself stated that any and all funds made available for Eurocal or its affiliates or designees were in custodianship. On February 27, 1989-two weeks after the agreement was signed-Slusser wrote to Hieber expressing his understanding that a custodial relationship existed between Hieber and his depositors. Wire advices ordered by IPC as early as March 7, 1989 confirm that deposits of IPC funds were made to VFS accounts. On March 14, 1989, a letter to IPC was prepared at Hieber's request stating in part that Sterling Bank through its trading entity VFS was to carry out trading for the account of IPC clients.
7 Slusser testified at the hearing that the February Agreement was renegotiated to provide for payment of fees, Tr. at 438-39. There is no evidence in the record of any subsequent agreement.
8 Before leaving for Germany, Slusser directed VFS employees to immediately invest all the IPC funds. In response to inquiries from German authorities, Slusser stated that he anticipated an approximate yield of eighteen to twenty percent on the IPC investments and predicted a loss of thirty percent if the assets were immediately liquidated. Notwithstanding Slusser's prediction of substantial losses if the positions held for the IPC funds were prematurely liquidated, during July and August of 1989 the respondents continuously bought and sold futures contracts and securities held on behalf of the IPC investors.
9 "DOE Ex._ _" Refers to the Division's exhibits in the record; "Resp's Ex.__" refers to the respondents' exhibits.
10 Slusser testified at the hearing that he was uncertain that he ever knew the terms of the prospectus. Tr. at 410. However, the record reflects that Slusser was aware of the major terms of the prospectus by June 1, 1989. His handwritten notes dated June 1, 1989, state that "65% of profit to client accts. on all accts/35% of profits to IPC on all funds." Testimony of VFS employees establishes that Slusser had the prospectus translated from German to English and that the prospectus was available and on display at VFS's headquarters office. Tr. at 113, 116-19, 121.
11 VFS previously had withdrawn $1,242,490 of the money it received from IPC pursuant to the February Agreement.
12 Slusser has not challenged the ALJ's finding that he violated section 4k(2) of the Act by failing to register as an AP.
13 CFTC Interpretative Letter no. 92-3, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,221 (Feb. 4, 1992); CFTC Interpretative Letter No. 95-95, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,589 (Oct. 30, 1995); CFTC Interpretative Letter No. 97-03, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,970 (Jan. 15, 1997); CFTC Interpretative Letter No. 97-09, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,976 (Feb. 6, 1997); CFTC Interpretative Letter No. 97-96, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,200 (Nov. 18, 1997); CFTC Interpretative Letter No. 97-100, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,225 (July 14, 1997).
14 CFTC Interpretative Letter No. 97-56, [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,106 (June 26, 1997).
15 At common law, the elements of fraud are (1) a material misrepresentation or omission of fact; (2) scienter; (3) reliance by the other party on the misrepresentation or omission; and (4) proximate injury suffered by the other party. Puckett, 903 F.2d at 1018; Commodity Futures Trading Commission v. American Metals Exchange Corp., 775 F.Supp. 767, 774 (D.N.J. 1991), aff'd in part and remanded on other grounds, 991 F.2d 71 (3d Cir. 1993).
16 Because the language of section 4b prohibits both fraud and attempted fraud, a requirement that the Division prove reliance in administrative enforcement actions would defeat the legislative purpose of section 4b. Attempts to deceive or defraud "by definition do not involve a completed act, and therefore reliance cannot be an element of a charge of attempted fraud." In re GNP Commodities, Inc., ¶ 25,360 at 39,218.
17 Courts do not require an agency to accept an adverse determination of the agency's statutory construction by a court of appeals as binding on the agency for all similar cases. Railway Labor Executives Ass'n v. ICC, 784 F.2d 959, 964 (9th Cir. 1986).
18 "The question of materiality is an objective one and turns on whether a reasonable investor would regard the fact as significantly changing the total data available to him or her. The ALJ, as trier-of-fact, is uniquely competent to resolve this mixed question of law and fact and to determine materiality. . . ." In re Citadel Trading Co., [1986-1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 23,082 at 32,187 (CFTC May 12, 1986).
19 The respondents argue that the ALJ erred in relying on the draft letter introduced into evidence by the Division because the Division failed to prove that the letter was mailed. Slusser admitted in a 1994 deposition that he mailed such a letter, a letter admitted into evidence from VFS's German legal counsel confirmed that he would mail the letter to the IPC participants, and a witness testified that Slusser had given him a copy of the letter in August 1989.
20 In any event, at the time when VFS sent the July letter to investors, it was receiving daily written confirmations from Cantor which showed the true profitability of the trading in VFS's account. Tr. at 310.
21 The respondents collected $2.3 million in unauthorized and unearned commissions from futures trading through their IB subsidiary, FR Trading. Moreover, notwithstanding the fact that the IPC prospectus specified that the Fund III and IV monies would be invested in financial futures, VFS opened securities accounts in its own name and in the name of its broker-dealer subsidiary FR Securities at Cantor. At the time when those accounts were closed, Slusser had directed Cantor to transfer a total of $950,000 of IPC money from the VFS securities account to FR securities. The respondents claim that these amounts represent legitimate commissions to FR securities. Resp. Br. at 24. No commissions earned by VFS or its subsidiaries can be characterized as legitimate as no agreement existed which entitled VFS to commissions from trading.
22 VFS opened its first trading account with Argus, an FCM, on March 15, 1989, and its first account with Stotler, also an FCM, on May 11, 1989. The account opening documents for the Argus and Stotler trading accounts do not list FR trading as an IB for VFS's accounts.
23 The record also reflects that Slusser, to avoid using FR Trading's commissions to pay for its expenses, entered into an agreement in May 1989 with McVean Trading, a registered non-clearing FCM, to provide back-office services for "an IB yet to be acquired." DOE Ex. 91; Tr. at 166-69. Slusser arranged for McVean to be paid for these services from the commodity trading accounts containing the IPC funds. Although VFS did not acquire FR Trading until July 13, McVean received between $237,000 and $400,000 from the IPC accounts for services ostensibly rendered between May and November 1989. DOE Ex. 94 at 7-9.
24 As evidence of their "good faith," the respondents argue that "immediately after Slusser learned that his companies held IPC monies, he took it upon himself to travel to Germany" in late May 1989 to cooperate with German investigatory authorities and "otherwise utilize his best efforts." Resp. Br. at 32. On the contrary, the record reflects that Slusser traveled to Germany to defend his companies against serious allegations made by the German authorities. Had Slusser not gone to Germany, the authorities likely would have commenced liquidation of the IPC funds immediately, eliminating Slusser's opportunity to profit from the funds.
25 Section 4o of the Act provides, inter alia, that it shall be unlawful for a CTA, AP of a CTA, CPO or AP of a CPO to employ any device, scheme, or artifice to defraud any client or participant or prospective participant, or to engage in any transaction, practice or course of business which operates as a fraud or deceit upon any client or participant, or any prospective client or participant.
The respondents have not challenged the ALJ's finding that FR Trading aided and abetted VFS's section 4o fraud and is thus liable for those violations under section 13(a) of the Act. To prevail on the aiding and abetting charge, the Division was required to show that FR Trading knew of the wrongdoing and intentionally assisted in it. In re Buckwalter, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 24,995 at 37,686 (CFTC Jan. 25, 1991). The record evidence established that FR Trading was a subsidiary of VFS that existed for the purpose of collecting commissions for the benefit of VFS from the IPC accounts, that it was controlled by Slusser, and that through Slusser it had knowledge of every aspect of the IPC matter. In these circumstances, the ALJ's liability findings were warranted.
26 The same conduct that violates section 4b can be used to establish a violation of section 4o(1)(A) and (B). In re GNP Commodities, Inc., ¶ 25,360 at 39,218.
27 The respondents repeatedly argue that the Division failed to introduce into evidence the terms and conditions of the remaining IPC funds, and thus failed to demonstrate that the respondents held funds that were solicited for Funds III and IV. The IPC prospectus refers only to Funds II, III and IV. The record reflects that the respondents also may have held some funds that were solicited for Fund II, which provided for an investment in financial futures via zero coupon bonds. As of June 2, 1989, Funds I and II were no longer being offered. According to an audit prepared by Peat, Marwick, no information was available with respect to Fund V; Funds M, S and V are described only briefly. Slusser's personal notes refer only to Funds III and II, with one reference to Fund II. A draft of "Circular Letter 4" to IPC participants, dated October 9, 1989, refers only to Funds II, III and IV.
28 For example, the respondents' contention that Slusser did not author the mid-July letter to IPC investors does not absolve Slusser of liability under section 13(b) because he knew that the letter had been prepared. "A controlling person's 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." Guttman, 1998 WL 205134 at *18. Control is the direct or indirect power to direct or cause the direction of management and policies; "failure to exercise such authority, or acquiescence in the usurpation of such authority by another, does not negate" a finding of control. Id. at *16. Similarly, the respondents' claim that Slusser is not liable for a $300,000 expense incurred by Hans Brinks does not undermine Slusser's liability as a controlling person, even if his testimony that he "objected" to the payment were credited. Tr. at 489. Slusser had the authority to stop the payment, and he failed to do so.
29 Although the respondents have not raised a due process challenge, it should be noted that the Supreme Court has held that due process requires notice of the severity of the penalty that may be imposed. BMW of North America, Inc. v. Gore, 517 U.S. 559, 574-75 (1998). Appropriate notice was given here.
30 The respondents have not challenged the cease and desist orders, permanent trading bans or registration revocations imposed by the ALJ. Because the respondents' violations involve fraud, they are subject to statutory disqualification from registration pursuant to section 8a(2)(E) of the Act. Consequently, their misconduct supports a statutory presumption of unfitness and warrants revocation of their registrations. In re Sundheimer, [1980-1982 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 21,245 at 25,220 (CFTC Sept. 16, 1981), aff'd, Sundheimer v. CFTC, 688 F.2d 150 (2d Cir. 1982), cert. denied, 460 U.S. 1022 (1983). Both the cease and desist order and the trading bans are warranted where, as here, there is a reasonable likelihood of continuing violations. Commodities Int'l Corp., ¶ 26,943 at 44,567.
31 The existence of demonstrable financial gain to respondents and loss to customers distinguishes customer fraud cases from trade practice cases, where violations of the act may be more readily quantifiable and financial impact less quantifiable, and results in the Commission's different appropach to civil monetary penalties. Compare In re Reddy, 1998 WL 44574 (CFTC Feb. 4, 1998); In re Rousso, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,133 (CFTC June 25, 1997), aff'd without opinion sub nom. Rousso v. CFTC, No. 97-4232 (2d Cir. Mar.11, 1998).
32 While penalties in apparently analogous cases may appear less stringent, the respondents' argument ignores not only the discretionary nature of the Comission's choice of sanctions, but also variables in the facts and circumstances of "comparable" cases. For instance, while the respondents observe that the respondent in Incomco converted $550,000 in customer funds and was assessed only $105,000 as a civil penalty, they overlook the fact that the respondent also was ordered to comply with his undertaking to pay $1 million to his FCM employer's bankruptcy trustee in a criminal action involving the same conduct. In re Incomco, [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 25,198 at 48,532 n.6 (CFTC Dec. 30, 1991).
33 Thus, in deciding Grossfeld, the Commission directly rejected its earlier approach to evaluating sanctions and announced that comparability with sanctions imposed in prior cases is no longer an element of its sanctions analysis.
34 Even if Section 2462 were interpreted to foreclose sanctions with respect to the respondents' conduct prior to May 24, 1989, a $10 million civil penalty is justified: of the $12,524,748 involved in this matter, only $776,563 (representing trading losses in VFS's commodity futures account at Goldenberg, hehmeyer & Co.) of the total losses occurred prior to May 24.
35 A motion to stay the effect of this decision pending reconsideration by the Commission or review by a court must be filed within 15 days of the date this order is served.