Commodity Futures Trading Com'n v. Zelener

• Decision Date: 20 October 2004
• Docket Number: No. 03-4245.,03-4245.
• Citation: 387 F.3d 624
• Parties: COMMODITY FUTURES TRADING COMMISSION, Plaintiff-Appellant, v. Michael ZELENER, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

387 F.3d 624

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

No. 03-4245.

United States Court of Appeals, Seventh Circuit.

Decided October 20, 2004.

Appeal from the United States District Court for the Northern District of Illinois Eastern Division. No. 03 C 4346—Matthew F. Kennelly, Judge.

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 FLAUM, Chief Judge, and POSNER, EASTERBROOK, RIPPLE, MANION, KANNE, ROVNER, WOOD, EVANS, WILLIAMS, and SYKES, Circuit Judges.

PETITION FOR REHEARING AND REHEARING EN BANC.

Plaintiff-appellant filed a petition for rehearing and rehearing en banc on August 11, 2004. All of the judges on the panel voted to deny rehearing. A judge called for a vote on the petition for rehearing en banc, but a majority of the active judges did not favor rehearing en banc. Accordingly, the petition is denied.

RIPPLE, Circuit Judge, dissenting from the denial of rehearing en banc.

This decision warrants the attention of the full court in an en banc proceeding. The analysis presented by the panel opinion cannot be squared with our prior precedent; it creates a conflict among the circuits; and it creates significant enforcement problems for the Commodity Futures Trading Commission ("CFTC").

Our earlier case law firmly establishes that this circuit, along with the other courts of appeals to have confronted the issue, employs the "totality of circumstances" approach to the determination of whether a contract is a futures contract.¹ See Nagel v. ADM Investor Serv., Inc., 217 F.3d 436 (7th Cir.2000); Lachmund v. ADM Investor Serv., Inc., 191 F.3d 777 (7th Cir.1999). We established this approach in Lachmund and Nagel in the context of hedge-to-arrive contracts for the sale of grain, which allowed the farmer to defer (rollover) his delivery obligations. In Lachmund, we recognized that

Although cash forward contracts and futures contracts are easily distinguishable in theory, it is frequently difficult in practice to tell whether a particular arrangement between two parties is a bona fide cash forward contract for the delivery of grain or whether it is a mechanism for price speculation on the futures market. Our task, therefore, is to establish a methodology for determining whether a particular contract is a cash forward contract exempt from regulation under the CEA or a futures contract subject to the requirements of the CEA.

....

[O]ur starting point must always be the words of the contract itself. The contract's terms will provide several indications of the nature of the transaction it memorializes. The document itself will reveal whether the agreement contemplates actual delivery, by indicating the following: whether the parties to the contract are in the business of producing or obtaining grain; whether the parties are capable of delivering or receiving actual grain in the quantities provided for in the contract; whether there is a definite date of delivery; whether the agreement explicitly requires actual delivery as opposed to allowing delivery obligations to be rolled indefinitely into the future; whether payment takes place only upon delivery; and whether the contract's terms are individualized, as opposed to standardized.

....

Indeed, because the CEA regulates transactions, it is often necessary to look beyond the written contract. See [Andersons, Inc. v. Horton Farms, Inc., 166 F.3d 308, 319-20 (6th Cir.1998)] (cautioning that "self-serving labels" that parties place on their contracts are not dispositive on the issue whether a contract is a cash forward or a futures contract); [CFTC v. Co Petro Mktg. Group, Inc., 680 F.2d 573, 581 (9th Cir.1982)] (noting that "no bright-line definition or list of characterizing elements is determinative"). In order to gain the fullest understanding possible of the parties' agreement and their purpose, we often must consider the course of dealings between the parties and the totality of the business relationship. See id. ("The transaction must be viewed as a whole with a critical eye towards its underlying purpose.").

Lachmund, 191 F.3d at 787. In Nagel, we refined the "totality of circumstances" approach and held that, when the following circumstances are present, a contract will be deemed a forward contract: (1) the contract specifies individualized terms such as place of delivery and quantity, so that the contract is not fungible with other contracts for the sale of the commodity, except for cases in which the seller promises to offset the contract; (2) parties to the contract are industry participants contracting in the commodity rather than non-industry speculators trading for the contract's price; (3) delivery can not be deferred indefinitely. Nagel, 217 F.3d at 441. We noted that, if one or more of these features is missing, the contract may or may not be a futures contract. Id. The circuits that have addressed this question follow a similar approach. See Grain Land Coop v. Kar Kim Farms, Inc., 199 F.3d 983, 990-92 (8th Cir.1999); Andersons, 166 F.3d at 317-22; CFTC v. Noble Metals Int'l, Inc., 67 F.3d 766, 772-73 (9th Cir.1995); Co Petro, 680 F.2d at 579-81.

The present case deals with speculative transactions for the sale or purchase of foreign currency; the contract called for settlement within forty-eight hours, however, every two days, the transaction was rolled forward and the customer maintained a position in an open currency market. The panel held that the rollover (indefinite delivery) did not convert these "spot" transactions into futures contracts. Slip Op. at 13.² The approach employed by the panel to reach that result departs substantially from our precedent.³ It squarely rejects the relevance of delivery in the context of financial futures:

Treating absence of "delivery" (actual or intended) as a defining characteristic of a futures contract is implausible. Recall the statutory language: a "contract of sale of a commodity for future delivery." Every commodity futures contract traded on the Chicago Board of Trade calls for delivery. Every trader has the right to hold the contract through expiration and to deliver or receive the cash commodity. Financial futures, by contrast, are cash settled and do not entail "delivery" to any participant. Using "delivery" to differentiate between forward and futures contracts yields indeterminacy, because it treats as the dividing line something the two forms of contract have in common for commodities and that both forms lack for financial futures.

Slip Op. at 7. Notably, the opinion does more than rely on a factual distinction between the speculative foreign currency transactions and hedge contracts for the sale of grain. It simply disagrees with the "totality of circumstances" approach employed in established law and, as the CFTC points out, engages in a debate with the approach set forth in Nagel. See Petition of the CFTC at 5 n. 2. Indeed, the panel opinion adheres closely to the view set forth in the district court in Nagel. See Nagel v. ADM Investor Serv., Inc., 65 F.Supp.2d 740 (N.D.Ill.1999) (Easterbrook, J., sitting by designation). After disparaging the analysis of Co Petro, 680 F.2d at 579-81,⁴ the panel opinion then rebukes the "totality of circumstances" approach as a general matter:

It is essential to know beforehand whether a contract is a futures or a forward. The answer determines who, if anyone, may enter into such a contract, and where trading may occur. Contracts allocate price risk, and they fail in that office if it can't be known until years after the fact whether a given contract was lawful. Nothing is worse than an approach that asks what the parties "intended" or that scrutinizes the percentage of contracts that led to delivery ex post. What sense would it make—either business sense, or statutory-interpretation sense—to say that the same contract is either a future or not depending on whether the person obliged to deliver keeps his promise? That would leave people adrift and make it difficult, if not impossible, for dealers (technically, futures commission merchants) to know their legal duties in advance. But reading "contract of sale of a commodity for future delivery" with an emphasis on "contract," and "sale of any cash commodity for deferred shipment or delivery" with an emphasis on "sale" nicely separates the domains of futures from other transactions.

Slip Op. at 6. Compare Nagel, 65 F.Supp.2d at 752. The panel in Nagel, acknowledging the concern, was not persuaded that the problem required the rejection of the totality of the circumstances test but rather its...