Commodity Futures Trading Com'n v. Zelener, 03-4245.

• Decision Date: 30 June 2004
• Docket Number: No. 03-4245.,03-4245.
• Citation: 373 F.3d 861
• Parties: COMMODITY FUTURES TRADING COMMISSION, Plaintiff-Appellant, v. Michael ZELENER, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

373 F.3d 861

COMMODITY FUTURES TRADING COMMISSION, Plaintiff-Appellant, v. Michael ZELENER, et al., Defendants-Appellees.

No. 03-4245.

United States Court of Appeals, Seventh Circuit.

Argued June 1, 2004.

Decided June 30, 2004.

Kirk T. Manhardt (argued), C. Maria Dill Godel, Commodity Futures Trading Commission, Office of the General Counsel, Washington, DC, for Plaintiff-Appellant.

Lloyd A. Kadish, Kadish & Associates, Scott E. Early (argued), Foley & Lardner, Chicago, IL, for Defendants-Appellees.

Before EASTERBROOK, KANNE, and ROVNER, Circuit Judges.

EASTERBROOK, Circuit Judge.

This appeal presents the question whether speculative transactions in foreign currency are "contracts of sale of a commodity for future delivery" regulated by the Commodity Futures Trading Commission. 7 U.S.C. § 2(a)(1)(A). Until recently almost all trading related to foreign currency was outside the CFTC's remit, even if an equivalent contract in wheat or oil would be covered. See Dunn v. CFTC, 519 U.S. 465, 117 S.Ct. 913, 137 L.Ed.2d 93 (1997) (describing the Treasury Amendment to the Commodity Exchange Act). But Congress modified the Treasury Amendment as part of the Commodity Futures Modernization Act of 2000, and today the agency may pursue claims that currency futures have been marketed deceitfully, unless the parties to the contract are "eligible contract participants". 7 U.S.C. § 2(c)(2)(B). "Eligible contract participants" under the Commodity Exchange Act are the equivalent of "accredited investors" in securities markets: wealthy persons who can look out for themselves directly or by hiring experts. 7 U.S.C. § 1a(12); 15 U.S.C. § 77b(a)(15). Defendants, which sold foreign currency to casual speculators rather than "eligible contract participants," are not protected by the Treasury Amendment except to the extent that it permits them to deal over-the-counter, while most other futures products are restricted to registered exchanges (called boards of trade) or "derivatives transaction execution facilities" (specialized markets limited to professionals).

The agency believes that some of the defendants deceived some of their customers about the incentive structure: salesmen said, or implied, that the dealers would make money only if the customers also made money, while in fact the defendants made money from commissions and markups whether the customers gained or lost. This allegation (whose accuracy has not been tested) makes it vital to know whether the contracts are within the CFTC's regulatory authority. The district judge concluded that the transactions are sales in a spot market rather than futures contracts. 2003 WL 22284295, 2003 U.S. Dist. LEXIS 17660 (N.D.Ill. Oct. 3, 2003).

AlaronFX deals in foreign currency. Two corporations doing business as "British Capital Group" or BCG solicited customers' orders for foreign currency. (Michael Zelener, the first-named defendant, is the principal owner and manager of these two firms.) Each customer opened an account with BCG and another with AlaronFX; the documents made it clear that AlaronFX would be the source of all currency bought or sold through BCG in this program, and that AlaronFX would act as a principal. A customer could purchase (go long) or sell (short) any currency; for simplicity we limit our illustrations to long positions. The customer specified the desired quantity, with a minimum order size of $5,000; the contract called for settlement within 48 hours. It is agreed, however, that few of BCG's customers paid in full within that time, and that none took delivery. AlaronFX could have reversed the transactions and charged (or credited) customers with the difference in price across those two days. Instead, however, AlaronFX rolled the transactions forward two days at a time — as the AlaronFX contract permits, and as BCG told the customers would occur. Successive extensions meant that a customer had an open position in foreign currency. If the dollar appreciated relative to that currency, the customer could close the position and reap the profit in one of two ways: take delivery of the currency (AlaronFX promised to make a wire transfer on demand), or sell an equal amount of currency back to AlaronFX. If, however, the dollar fell relative to the other currency, then the client suffered a loss when the position was closed by selling currency back to AlaronFX.

The CFTC believes that three principal features make these arrangements "contracts of sale of a commodity for future delivery": first, the positions were held open indefinitely, so that the customers' gains and losses depended on price movements in the future; second, the customers were amateurs who did not need foreign currency for business endeavors; third, none of the customers took delivery of any currency, so the sales could not be called forward contracts, which are exempt from regulation under 7 U.S.C. § 1a(19). This subsection reads: "The term `future delivery' [in § 2(a)(1)(A)] does not include any sale of any cash commodity for deferred shipment or delivery." Delivery never made cannot be described as "deferred," the Commission submits. The district court agreed with this understanding of the exemption but held that the transactions nonetheless were spot sales rather than "contracts... for future delivery." Customers were entitled to immediate delivery. They could have engaged in the same price speculation by taking delivery and holding the foreign currency in bank accounts; the district judge thought that permitting the customer to roll over the delivery obligation (and thus avoid the costs of wire transfers and any other bank fees) did not convert the arrangements to futures contracts.

In this court the parties debate the effect of Nagel v. ADM Investor Services, Inc., 217 F.3d 436 (7th Cir.2000), and Lachmund v. ADM Investor Services, Inc., 191 F.3d 777 (7th Cir.1999). These decisions held that hedge-to-arrive contracts in grain markets, which allow farmers to roll their delivery obligations forward indefinitely and thus to speculate on grain prices (while selling their crops on the cash market), are not futures contracts. The rollover feature offered by AlaronFX gives investors a similar option, and thus one would think requires a similar outcome. The CFTC seeks to distinguish these decisions on the ground that farmers at least had a cash commodity, which they nominally sold to the dealer that offered the hedge-to-arrive contract (though they did not necessarily deliver grain to that entity). AlaronFX and BCG acknowledge this difference but say that it is irrelevant; they rely heavily on Chicago Mercantile Exchange v. SEC, 883 F.2d 537, 542 (7th Cir.1989), where we wrote:

A futures contract, roughly speaking, is a fungible promise to buy or sell a particular commodity at a fixed date in the future. Futures contracts are fungible because they have standard terms and each side's obligations are guaranteed by a clearing house. Contracts are entered into without prepayment, although the markets and clearing house will set margin to protect their own interests. Trading occurs in "the contract", not in the commodity. Most futures contracts may be performed by delivery of the commodity (wheat, silver, oil, etc.). Some (those based on financial instruments such as T-bills or on the value of an index of stocks) do not allow delivery. Unless the parties cancel their obligations by buying or selling offsetting positions, the long must pay the price stated in the contract (e.g., $1.00 per gallon for 1,000 gallons of orange juice) and the short must deliver; usually, however, they settle in cash, with the payment based on changes in the market. If the market price, say, rose to $1.50 per gallon, the short would pay $500 (50¢ per gallon); if the price fell, the long would pay. The extent to which the settlement price of a commodity futures contract tracks changes in the price of the cash commodity depends on the size and balance of the open positions in "the contract" near the settlement date.

These transactions could not be futures contracts under that definition, because the customer buys foreign currency immediately rather than as of a defined future date, and because the deals lack standard terms. AlaronFX buys and sells as a principal; transactions differ in size, price, and settlement date. The contracts are not fungible and thus could not be traded on an exchange. The CFTC replies that because AlaronFX rolls forward the settlement times, the transactions are for future delivery in practice even though not in form; and the agency insists that fixed expiration dates and fungibility are irrelevant. It favors a multi-factor inquiry with heavy weight on whether the customer is financially sophisticated, able to bear risk, and intended to take or make delivery of the commodity. See Statutory Interpretation Concerning Forward Transactions, 55 Fed.Reg. 39188, 39191 (Sept. 25, 1990). See also CFTC v. Co Petro Marketing Group, Inc., 680 F.2d 573, 577 (9th Cir.1982).

Instead of trying to parse language in earlier decisions that do not wholly fit this situation, we start with the statute itself. Section 2(a)(1)(A) speaks of "contracts of sale of a commodity for future delivery". That language cannot sensibly refer to all contracts in which settlement lies ahead; then it would encompass most executory contracts. The Commission concedes that it has a more restricted scope, that it does not mean anything like "all executory contracts not excluded as forward contracts by § 1a(19)." What if there were no § 1a(19)? Until 1936 that exemption was limited to deferred delivery of crops. (Compare the Grain Futures Act of 1922, 42 Stat. 998 (1922), with the Commodity Exchange Act of 1936, 49 Stat. 1491 (1936).) Then until 1936 a contract to deliver heating oil in the winter would have been a "futures contract," and only a futures commission merchant could have been in the oil business! (Moreover, those contracts...