Drexel Burnham Lambert Inc. v. Commodity Futures Trading Com'n

• Citation: 850 F.2d 742
• Decision Date: 24 June 1988
• Docket Number: No. 87-1372,87-1372
• Parties: , 271 U.S.App.D.C. 49 DREXEL BURNHAM LAMBERT INC. and David Joe Ragan, Petitioners, v. COMMODITY FUTURES TRADING COMMISSION and Sansom Refining Company, Respondents.
• Court: United States Courts of Appeals. United States Court of Appeals (District of Columbia)

Page 742

850 F.2d 742

97 A.L.R.Fed. 521, 271 U.S.App.D.C. 49

DREXEL BURNHAM LAMBERT INC. and David Joe Ragan, Petitioners, v. COMMODITY FUTURES TRADING COMMISSION and Sansom Refining

Company, Respondents.

No. 87-1372.

United States Court of Appeals,

District of Columbia Circuit.

Argued April 29, 1988.

Decided June 24, 1988.

Richard L. Josephson, Houston, Tex., with whom Charles M. Darling, IV and J. Patrick Berry, Washington, D.C., were on the brief, for petitioners Drexel Burnham Lambert Inc., et al.

James T. Kelly, Asst. Gen. Counsel, Commodity Futures Trading Com'n, with whom Jay L. Witkin, Deputy Gen. Counsel, Commodity Futures Trading Com'n, Washington, D.C., was on the brief, for respondent Commodity Futures Trading Com'n.

Paul J. McMahon, for respondent Sansom Refining Co.

Michael O. Finkelstein, Robert C. Macek, Mahlon M. Frankhauser and Charles R. Mills, New York City, were on the brief for amicus curiae, Futures Industry Ass'n, Inc. Mary L. Schapiro, Washington, D.C., also entered an appearance for amicus curiae, Futures Industry Ass'n, Inc.

Before EDWARDS and STARR, Circuit Judges, and WEIGEL ^*, Senior District Judge.

Opinion for the Court filed by Circuit Judge HARRY T. EDWARDS.

Opinion concurring in part and dissenting in part filed by Circuit Judge STARR.

HARRY T. EDWARDS, Circuit Judge:

Drexel Burnham Lambert Inc. ("Drexel") and one of its former brokers, David Ragan, petition for review of a decision by the Commodity Futures Trading Commission ("Commission") ordering them to pay Sansom Refining Company ("Sansom") approximately $1.3 million plus interest and costs for trading losses. The Commission found Drexel liable for the losses in Sansom's account because Richard Robinson, the Sansom employee who initiated the unprofitable trades, lacked actual and apparent authority to buy or sell commodity futures on Sansom's behalf, and because Sansom never ratified these trades. The Commission further ruled that Sansom was not estopped from claiming injury.

We affirm the Commission's decision in substantial part. We agree that Ragan's reckless response to Robinson's unauthorized trading orders violated section 4b of the Commodity Exchange Act, 7 U.S.C. Sec. 6b, and that Drexel was liable for his actions under section 2(a)(1)(A) of the Act, 7 U.S.C. Sec. 4. We have concluded, however, that the Commission erred in ruling that the petitioners violated section 4d(2) of the Act, 7 U.S.C. Sec. 6d(2). Accordingly, we grant the petition for review with respect to the latter finding and reverse the Commission's decision on that point. The Commission also failed to address Drexel's argument that it should not bear the entire loss because Sansom failed to mitigate damages. We therefore remand the case to the Commission for further findings on this issue.

I. BACKGROUND

In 1980, Sansom was engaged in the business of buying precious metal as scrap, refining it, and reselling the purified product to larger refiners. Its two officers were Jackson Loughridge, President and Treasurer, and Albert Waterman, Vice-President and Secretary. Each owned 45% of Sansom's stock. In March 1980, Loughridge discussed various means of reducing Sansom's income tax liabilities with Drexel brokers. Throughout these discussions, Loughridge considered the advice of Richard Robinson, a Sansom employee. ¹ Robinson apparently knew more about tax law and commodity trading than did Loughridge, and Loughridge often consulted with him in such matters.

In April 1980, Loughridge and Robinson met with Ragan at Drexel's Houston office. Ragan suggested that Sansom establish an interest rate arbitrage program involving the purchase and sale of Treasury bills and Treasury bill futures, in order to convert its profits from ordinary income to long-term capital gains. Shortly thereafter, Loughridge agreed on Sansom's behalf to accept Ragan's proposal, which entailed an initial commitment of between $300,000 and $500,000. In early May 1980, Loughridge and Waterman executed Drexel's standard account-opening documents. They granted Ragan discretionary authority to trade Sansom's account. They also signed a corporate resolution form provided by Drexel, which Loughridge modified (with Waterman's permission) to authorize Loughridge alone--not Waterman as well--to trade the account. Although the corporate resolution form permitted Loughridge "to appoint any other person or persons to do any and all things which [he] is hereby empowered to do, and generally to do and take all action necessary in connection with the account," Appendix ("App.") at 812, neither Robinson nor any other person was ever authorized by Loughridge to initiate trades on Sansom's behalf.

On May 15, 1980, Ragan began buying Treasury bills for Sansom's account. Ragan telephoned Loughridge to report these initial purchases, and Drexel sent Sansom a statement, marked "Attn. Jack Loughridge," confirming the transactions. After several telephone calls, Loughridge told Ragan not to call him to report his dealings in the account; all telephonic reports, he said, should be made directly to Robinson. After reviewing the first few written account statements, Loughridge apparently ceased reading them as well. Instead, he relied on Robinson to monitor the statements and to inform him of the account's status every week or so. Between May 15 and June 10, 1980, Sansom deposited $400,000 in its account with Drexel.

On June 11, 1980, Robinson telephoned Ragan and placed an order to sell 48 pork belly futures for Sansom's account. Ragan executed the order, without asking Loughridge whether he had authorized the sale or delegated to Robinson his exclusive authority to trade. Ragan had good reasons to be suspicious of the order, both because he had never been advised that Robinson had authority to trade for Sansom, and because the order was patently at odds with the well-understood tax goals of the client's account.

On June 19, 1980, Ragan, Robinson and Loughridge met in Philadelphia. Ragan spoke very generally about Sansom's trading program and reported that all was well. Ragan did not mention the sale of pork belly futures he had made eight days before at Robinson's behest, although at that meeting he could easily have verified Robinson's authority to initiate trades. Ragan also furnished Loughridge with a list of transactions in Sansom's account through June 11. Significantly, however, the list did not include the sale of pork belly futures on June 11 that Robinson had requested, even though three other transactions involving Treasury bills were listed for that date.

On July 9, 1980, Robinson directed Ragan to offset half of the pork belly futures at a loss of more than $77,000. Ragan did so, again without telephoning Loughridge to confirm Robinson's authority to initiate trades. During the rest of July, Robinson ordered numerous other unprofitable trades in pork belly and live cattle futures. In August and September, he speculated even more heavily, accumulating huge losses.

At no time did Ragan ask Loughridge whether Robinson was authorized to trade for Sansom. When Sansom's losses began to mount, however, he did express his worries to Robinson, who stated that Sansom had hedged the unprofitable trades through orders placed at Bache Halsey Stuart Shields Inc. ("Bache"). Ragan telephoned a broker at Bache to confirm Robinson's story. He was told that Sansom's account at Bache enjoyed a surplus roughly equal to Sansom's aggregate losses at Drexel. The Bache broker refused to tell Ragan, however, what trades had been made through that account. Hence, Ragan could not corroborate Robinson's assertion, although his fears were somewhat allayed. In fact, Sansom's account at Bache was not used to hedge Robinson's trades at Drexel.

Throughout this period, Drexel regularly sent account statements to Sansom, marked to the attention of Loughridge. The statements requested the client to report any inaccuracies immediately. Sansom never complained about the unauthorized trades, because Loughridge trusted Robinson to read the statements and apprise him of the account's status, and Robinson never mentioned the unauthorized, speculative commodity trades that he had placed with Ragan. Sansom deposited over $1.3 million in the account between July and September 1980 in order to cover its losses. Most of the checks were signed by Waterman. Neither Loughridge nor Waterman questioned Robinson when he presented the checks for their signatures.

In mid-September 1980, Ragan and Loughridge discussed a gold trade that Ragan had made for Sansom's account. It is unclear who initiated the call, or how Loughridge learned of the trade. However, it is clear that, as soon as Loughridge became aware of the unauthorized trade, he was explicit in instructing Ragan not to trade in gold. Even though Loughridge expressed concern about commodity trading in the company's account, Ragan never volunteered any information about the orders that had been placed by Robinson, nor did he use the occasion of their September discussion to inquire regarding the efficacy of the commodity trades.

On September 21, 1980, Robinson finally confessed to Loughridge that he had speculated in Sansom's account and had incurred colossal losses. Loughridge promptly closed out all the open commodity contracts the following day. Sansom maintained its account at Drexel, however, so as not to lose the tax benefits it expected to reap from its Treasury bill spreads.

On June 3, 1982, Sansom filed a reparations claim with the Commission against Drexel and Ragan. Sansom's complaint alleged violations of section 4b of the Commodity Exchange Act, 7 U.S.C. Sec. 6b. ² The Administrative Law Judge ("ALJ") who conducted a hearing on Sansom's complaint ruled in favor of Drexel and Ragan and dismissed Sansom's action on May 27, 1986. ³ He found that, although Robinson lacked both actual and apparent authority to initiate trades in Sansom's account, Sansom was...