Commodity Futures Trading Comm'n v. Vartuli

• Decision Date: 01 August 1999
• Docket Number: Docket No. 98-6280,98-6281
• Citation: 228 F.3d 94
• Parties: (2nd Cir. 2000) COMMODITY FUTURES TRADING COMMISSION, Plaintiff Appellee Cross Appellant, v. ANTHONY VARTULI, Defendant-Appellant-Cross-Appellee, AVCO FINANCIAL CORP., J. MICHAEL GENT, Defendants
• Court: U.S. Court of Appeals — Second Circuit

Page 94

228 F.3d 94 (2nd Cir. 2000)

COMMODITY FUTURES TRADING COMMISSION, Plaintiff Appellee Cross Appellant, v. ANTHONY VARTULI, Defendant-Appellant-Cross-Appellee, AVCO FINANCIAL CORP., J. MICHAEL GENT, Defendants.

Docket No. 98-6280, 98-6281

August Term, 1999

UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT

Argued: September 13, 1999

Decided: September 22, 2000

Appeal from a judgment of the United States District Court for the Southern District of New York (John F. Keenan, Judge) granting injunctive relief against and ordering disgorgement of profits by defendants AVCO Financial Corp. and Anthony Vartuli. Affirmed in part; reversed and remanded in part. [Copyrighted Material Omitted]

[Copyrighted Material Omitted] MICHAEL E. SCHOEMAN, Schoeman, Marsh & Updike, LLP, New York, NY (David Black, of counsel), for Defendant-Appellant-Cross-Appellee Anthony Vartuli,

MARTIN B. WHITE, Commodities Futures Trading Commission (Daniel R. Waldman, General Counsel, J. Douglas Richards, Deputy General Counsel), for Plaintiff-Appellee-Cross-Appellant Commodity Futures Trading Commission.

Before: VAN GRAAFEILAND, CALABRESI and SACK, Circuit Judges.

VAN GRAAFEILAND, Circuit Judge, concurs in Parts I and IV and concurs in the result as to Parts II and III.

SACK, Circuit Judge:

The Commodity Futures Trading Commission (the "Commission" or the "CFTC"), an independent federal regulatory agency charged with the administration and enforcement of the Commodity Exchange Act, 7 U.S.C. §§ 1 et seq. (the "CEA") and the regulations promulgated thereunder, 17 C.F.R. §§ 1.1 et seq., brought a civil enforcement action in the United States District Court for the Southern District of New York against defendants AVCO Financial Corp., Anthony Vartuli and J. Michael Gent. In its complaint, the Commission claimed that the defendants had violated the CEA by manufacturing selling and advertising a computer program called "Recurrence," which the defendants fraudulently claimed provided profitable trading opportunities for its purchasers and users in the market for currency futures. The Commission sought a permanent injunction barring future violations of the CEA by the defendants; awards of disgorgement, restitution, and rescission; and civil monetary penalties.

Subsequent to the commencement of the Commission's enforcement action, AVCO filed a voluntary petition in bankruptcy. The district court (John F. Keenan, Judge) ruled, however, that the bankruptcy filing did not stay the Commission's action because the Commission was seeking to enforce its regulatory power and the action was therefore exempt from the automatic stay under 11U.S.C.§362(b)(4). See CFTC v. AVCO Fin. Corp., 979 F. Supp. 232, 235 (S.D.N.Y. 1997) ("AVCO I"). When AVCO nevertheless failed to appear, a default judgment was entered against it. The district court then conducted a bench trial which, pursuant to Fed. R. Civ. P. 55(b)(2), was in the form of an inquest as to AVCO because of its default in order to make the findings of fact and conclusions of law necessary to determine whether and to what extent to impose injunctive relief against the defendants and to determine appropriate ancillary relief, if any. After trial, the district court entered judgment against AVCO and Vartuli on all three counts of the Commission's complaint. See CFTC v. AVCO Fin. Corp., 28 F. Supp. 2d 104, 122 (S.D.N.Y. 1998) ("AVCO II"). The complaint against Gent was dismissed in its entirety. See id. The court issued a permanent injunction against AVCO and Vartuli and ordered the disgorgement of the profits that they garnered from the sale of Recurrence. See id. at 120-21. Vartuli appealed. The Commission cross-appealed on the issue of the size of the disgorgement award.

Because we agree that AVCO and Vartuli violated the CEA, we affirm the district court's holding to that effect, although on somewhat different grounds. Because the conduct enjoined by the district court included the dissemination of Recurrence as speech and the district court did not first engage in prior restraint analysis, however, we conclude that the injunctive relief granted by the district court is in part unconstitutional, and to that extent we reverse and remand for the injunction to be modified. On remand we also direct the district court to determine whether an issue identified in Part II of this opinion, below, relating to whether customers of AVCO were "clients" under the applicable statutory language, was raised before it, and, if it was, to decide that issue in the first instance. We affirm the award of disgorgement.

BACKGROUND

The facts relating to this appeal, which are not substantially in dispute, are described extensively in AVCO II. In brief, the defendant Anthony Vartuli incorporated the Taurus Group, later renamed AVCO Financial Corp., in 1987. AVCO's corporate purpose, according to its certificate of incorporation, was "to provide investment advice in stocks, options and commodities." In 1989 AVCO, of which Vartuli was the sole shareholder, began marketing a set of materials called the "Recurrence" system, which Vartuli had developed with defendant Gent. Five versions of Recurrence were eventually produced (Recurrence I-V), the first two in book form and the latter three as computer software on disk. In this appeal, we are concerned principally with the computerized versions.

AVCO told its customers to obtain a market reporting service to feed current market prices for Swiss franc future contracts (or, for Recurrence V, Japanese yen future contracts) into a computer loaded with the Recurrence program. Recurrence would then analyze the transactions taking place in the futures market and give the user instantaneous "buy" or "sell" signals. AVCO claimed that following these signals would enable Recurrence users to trade futures contracts profitably. According to the parties' Joint Pretrial Order in the district court:

The Defendants' customers pay AVCO's licensing fee, and, if they wish to follow the instructions given by the Defendants' system themselves, install the Defendants' computer program on their personal computers, procure a market reporting service to feed current market prices to the computer, and then act on the instructions given by the Defendants' system.

In addition to selling the system, AVCO gave occasional supplemental advice to Recurrence users by telephone. It also provided customers with a list of "authorized brokers" who were willing to trade for the account of an AVCO customer using the Recurrence system if the purchaser of the system did not want to order each specific transaction him- or herself.

AVCO advertised the Recurrence system, which sold for prices ranging from $1500 for Recurrence I to $4500 for Recurrence IV, extensively. The advertising made clear that Recurrence was being sold as a system for trading commodities futures, and that for the system to function properly its commands were to be followed explicitly. A Recurrence ad run in the 1995 Partnership Packet, for example, said:

You'll be advised on what pattern is present, at what price to buy or sell, at what price to place your protective stop, and where to take profits.... All the trader needs to do is call [his or her] broker and place the appropriate trades."

Recurrence also told potential purchasers:

[Recurrence's] message gives you a specific buy or sell recommendation, as well as a specific stop and profit objective. You just call your broker and give the complete order (you can even read the instructions right off your screen) and then sit back and watch as Recurrence monitors the market and your position in real time.

(Emphasis in original.) An ad run in multiple editions of Futures Magazine informed prospective customers that they must "follow the signals with no second-guessing." And an advertisement that appeared in various editions of various publications warned that a Recurrence customer had to be possessed of a "lack of ego" in order for him or her to "begin taking profits immediately."

From 1991 to 1997, AVCO's advertisements for the Recurrence system claimed some remarkable results. AVCO advertised that "Recurrence III makes money automatically," "the system turned a $10,000 trading account into a $544,704 fortune-a return of 833% per year," and, "If you're serious about making money trading the markets, see the enclosed verified performance summary showing how Recurrence IV turned $2,500 into well over $130,000 trading only one Swiss Franc futures contract." But AVCO's claims were based on computer-generated hypothetical use of the system rather than actual trades, a fact not disclosed in the advertisements.

In addition to mass-media advertisements, AVCO also sent promotional materials to prospective customers. The order form that accompanied these materials contained a disclaimer that began:

CFTC Disclosure: While the numbers used in this literature are "Real Time Data" the CFTC requires the following disclaimer on all market related literature. Hypothetical or Simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading.

(Emphasis in the original.)

AVCO's advertisements were successful. Total revenue from sales of the system grew to more than four million dollars.

The results of actual trading using the Recurrence system did not live up to AVCO's promotional claims. The district court found that trading as directed by the Recurrence system, whether conducted by individuals or "authorized broker[s]," resulted in substantial losses. AVCO II, 28 F. Supp. 2d at 113. Even after customers complained to AVCO and Vartuli that Recurrence's performance had been poor, they continued to make claims about the system's extraordinary profitability.

The Commission filed a three-count complaint against AVCO, Vartuli and Gent. Count I charged the defendants with solicitation fraud in violation of Section 4b(a...