Commodities Fut. Trad. v. Commodities Fluctuations

• Decision Date: 06 April 1984
• Docket Number: No. 83 Civ. 5909 (WK).,83 Civ. 5909 (WK).
• Citation: 583 F. Supp. 1382
• Parties: COMMODITIES FUTURES TRADING COMMISSION, Plaintiff, v. COMMODITIES FLUCTUATIONS SYSTEMS, INC., D.E. Jones Commodities, Inc. and Karen T. Genovese, Defendants.
• Court: U.S. District Court — Southern District of New York

583 F. Supp. 1382

COMMODITIES FUTURES TRADING COMMISSION, Plaintiff, v. COMMODITIES FLUCTUATIONS SYSTEMS, INC., D.E. Jones Commodities, Inc. and Karen T. Genovese, Defendants.

No. 83 Civ. 5909 (WK).

United States District Court, S.D. New York.

April 6, 1984.

Commodity Futures Trading Commission by Patricia A. McGovern, Audrey R. Hirschfeld, New York City, for plaintiff.

Baer, Marks & Upham by Debra R. Linfield, Barry J. Mandel, New York City, for defendants Karen T. Genovese and Commodity Fluctuations Systems.

Louis F. Burke & Associates by Louis F. Burke, Jeffrey Levy, New York City, for defendant D.E. Jones Commodities, Inc.

MEMORANDUM & ORDER

WHITMAN KNAPP, District Judge.

The Commodity Futures Trading Commission (the "Commission") has applied for preliminary injunctive relief against D.E. Jones Commodities, Inc. ("Jones") for alleged violations of § 4b(A) of the Commodities Exchange Act, as amended (the "Act"), 7 U.S.C. § 6b(A) and § 166.3 of the Regulations promulgated thereunder ("Regulations") 17 C.F.R. § 166.3. Our decision in this case is based on evidence presented at a hearing which commenced on November 9, 1983 and continued through November 17th and on post-hearing papers submitted by the parties. The Commission asserts two violations for which it seeks relief. First, it claims that Jones violated the anti-fraud provisions of the Act, § 4b(A), 7 U.S.C. § 6b(A), through the acts of Commodity Fluctuations Systems ("CFS") and CFS salespersons who were Associated Persons ("AP's") of Jones. Second, it asserts that Jones failed to supervise CFS and the AP's in violation of its obligation to do so under § 166.3 of the Regulations, 17 C.F.R. § 166.3. We will first address the Commission's assertions that the Act has been violated by Jones and then the propriety of injunctive relief.

JONES'S ALLEGED FRAUD

The Act contains a broad anti-fraud provision. Section 4b provides in pertinent part:

It shall be unlawful ... (2) for any person, in or in connection with any order to make, or the making of, any contract of sale of any commodity for future delivery, made or to be made, on or subject to the rules of any contract market, for or on behalf of any other person ... (A) to cheat or defraud or attempt to cheat or defraud such other person. 7 U.S.C. § 6b(A).

Following an evidentiary hearing in November, we found that CFS salespersons had violated that section by misrepresenting certain risks attendant to commodities trading.¹ The violations of the salespersons were, of course, imputed to their employer, CFS. After finding that such violations were likely to continue, we issued an injunction against CFS. The question before us now is whether the acts of those salespersons may be imputed to Jones, with whom the salespersons were registered as Associated Persons.

The Commission asserts that the CFS salespersons/Jones AP's were agents of Jones, and that we must impute liability to Jones for their fraudulent acts under § 2(a)(1) of the Act. That Section provides:

The act, omission or failure of any official, agent or other individual, association or partnership, corporation or trust, within the scope of his employment or office shall be deemed the act, omission or failure of such individual, association, partnership, corporation or trust, as well as of such official, agent or other person. 7 U.S.C. § 4.

Although we find that Jones itself committed no fraud, we must impute the fraudulent acts of the CFS salespersons to Jones under the statute just quoted.

The CFS salespersons at issue are those hired by CFS who solicited accounts for a program which CFS developed and marketed called the Extended Futures Account ("EFA"). The salespersons marketed the account largely by telephoning potential customers and then sending them promotional literature. In these telephone solicitations salespersons identified themselves as representatives of CFS.² The materials distributed, with the exception of two documents (a Jones application and a Jones risk disclosure statement) are developed and packaged by CFS. CFS reviews the hiring of the AP's, retains control over their activities, arranges for compensation, and retains the right to terminate the relationship at any time.

Although these salespersons are hired and supervised by CFS to market a CFS program, they have a relationship with Jones which makes them agents within the meaning of § 2(a)(1). The salespersons involved in this case were each registered with Jones as an AP³ and Jones carried the accounts which these AP's solicited. At the end of a successful solicitation a customer completed an application to purchase which was on a Jones letterhead, made his or her check payable to Jones, and sent the purchase money directly to Jones. Jones received the money, sent to CFS that portion of the check designated by CFS as a supervisory fee,⁴ cleared the trade, maintained the account, and, for its services, took a fee of $13.00 for trades cleared on the New York Exchange and $15.00 for trades on the Chicago Exchange. From the evidence we must conclude that the CFS salespersons/Jones AP's solicited accounts in part at least for Jones's benefit and were, therefore, agents of Jones. Accordingly, we must impute liability for the agents' misconduct to Jones under § 2(a)(1).

JONES'S ALLEGED FAILURE TO SUPERVISE

Jones, as a Commission registrant, has an obligation to supervise the activities of the persons registered with it as Associated Persons. Section 166.3 of the Regulations requires that:

Each Commission registrant ... must diligently supervise the handling of all commodity interest accounts carried, operated or advised by the registrant and all other activities of its partners, officers, employees and agents (or persons occupying a similar status or performing a similar function) relating to its business as a Commission registrant. 17 C.F.R. § 166.3 (1983)

Although Congress did not define diligent supervision in this context, we must assume that Congress meant to provide some protection to customers by requiring that AP's — who directly solicit the public — be supervised by an entity registered with the Commission.⁵ Effective supervision, we think, would have to include some kind of review of promotional materials, customer accounts, and some kind of supervision of AP solicitations.

We find that although Jones acted in good faith in establishing procedures enabling supervision and in retaining contractual rights to supervise CFS salespersons/Jones AP's, it failed in its obligation to carry out those supervisory rights and duties. The contract between CFS and Jones provided that CFS was responsible for maintaining a compliance officer who would supervise the employees and insure compliance with all applicable law, rules and practices of the Commission. Whether Jones could delegate some of its supervisory obligations to CFS is an open question. But it appears that even if it could, Jones took no steps to discover whether CFS actually maintained a compliance officer who supervised anyone. The agreement further required CFS to submit all promotional material and disclosure documents given to customers to Jones for prior approval. There is no evidence to suggest that Jones ever obtained any such submission or reviewed such material prior to distribution.

Jones points to several other steps taken to ensure appropriate supervision. These include statements by Ms. Genovese, president of CFS, that compliance memos and National Futures Association Rules were routinely distributed to brokers, that lectures were given to brokers, and that phone calls were monitored through telephone banks. Whether these steps occurred at all — and as to that we have some doubt — they cannot be used to prove Jones's fulfillment of its supervisory obligations. Jones is required to do something more than contract away its supervisory role.

PROPRIETY OF INJUNCTIVE RELIEF

Although we find that Jones failed to diligently supervise the handling of the commodity accounts it carried for CFS and the activity of its AP's, and although we impute liability for the fraudulent acts of the CFS salespersons to Jones, we are not persuaded that an injunction would be appropriate.

To obtain statutory injunctive relief the Commission must establish (1) a prima facie showing of violations of the Act and (2) a reasonable likelihood that the violations will continue unless enjoined. Commodity Futures Trading Commission v. British American Commodities Options Corp. (2d Cir.1977) 560 F.2d 135, 141, cert. denied, 438 U.S. 905, 98 S.Ct. 3123, 57 L.Ed.2d 1147; Securities & Exchange Commission v. Manor Nursing Centers, Inc. (2d Cir.1972) 458 F.2d 1082, 1100. Although the first requirement has been satisfied, we find there to be little likelihood that any violations will continue and so we decline to issue an injunction. We are well aware that mere cessation of the illegal activity is an insufficient basis for denying statutory injunctive relief. Securities & Exchange Commission v. Management Dynamics, Inc. (2d Cir.1975) 515 F.2d 801, 807. Rather, a court must look at the totality of the circumstances surrounding the particular defendant and the violations committed. Id., Securities & Exchange Commission v. Universal Major Industries (2d Cir.1976) 546 F.2d 1044, 1048, cert. denied 434 U.S. 834, 98 S.Ct. 120, 54 L.Ed.2d 95.

In this case, we were impressed by the prompt attention given by Jones to problems of which it was notified relating to EFA accounts. No evidence was offered which would indicate that Jones did not properly attend to any problems relating to CFS or CFS salespersons/Jones AP's of which it was aware. We also note counsel's representation at oral argument that when Jones became aware that some CFS salespersons/Jones AP's were misinforming customers as to fees, Jones met with CFS and developed a new application form which required the customer to write the fee amount in his or her own handwriting....