Commodity Futures Trading Com'n v. Erskine

• Citation: 512 F.3d 309
• Decision Date: 09 January 2008
• Docket Number: No. 06-3896.,06-3896.
• Parties: COMMODITY FUTURES TRADING COMMISSION, Plaintiff-Appellant, v. Ross ERSKINE, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Sixth Circuit

512 F.3d 309

COMMODITY FUTURES TRADING COMMISSION, Plaintiff-Appellant, v. Ross ERSKINE, et al., Defendants-Appellees.

No. 06-3896.

United States Court of Appeals, Sixth Circuit.

Argued: July 25, 2007.

Decided and Filed: January 9, 2008.

ARGUED:

Martin B. White, Commodity Futures Trading Commission, Washington, D.C., for Appellant. Brent L. English, Law Office of Brent L. English, Cleveland, Ohio, for Appellees.

ON BRIEF:

Nancy R. Page, Commodity Futures Trading Commission, Washington, D.C., for Appellant. Brent L. English, Law Office of Brent L. English, Cleveland, Ohio, for Appellees.

Before: BATCHELDER and DAUGHTREY, Circuit Judges; ACKERMAN, District Judge.^*

OPINION

ALICE M. BATCHELDER, Circuit Judge.

The Commodities Futures Trading Commission (CFTC) sued Ross Erskine and his company, Goros, LLC, (collectively "Goros") in federal court, alleging that Goros had misrepresented facts and omitted pertinent information when soliciting customers to trade in foreign currency, which violated the Commodity Exchange Act (CEA), 7 U.S.C. §§ 1-27. As a jurisdictional predicate, the CFTC alleged that the trades at issue were "futures contracts" governed by the CEA and that the CFTC is authorized to "enjoin or restrain violations" of that Act. Id. at § 13a-1. Goros denied the accusations, denied that the trades were "futures contracts," and challenged the CFTC's jurisdiction. The district court agreed with Goros as to the nature of the trades and the jurisdiction of the CFTC and granted summary judgment to Goros. The CFTC appealed and we must now decide whether the trades at issue were "futures contracts" subject to the CFTC's jurisdiction. Because we conclude that they were not, we AFFIRM.

I.

A.

In 2001-2002, Goros sales representatives convinced 20 customers (with $472,822 in initial deposits) to open accounts with Goros and grant Goros power of attorney to trade foreign currency on their behalves. Goros traded through two registered "futures commission merchants" (FCMs) — Gain Capital, Inc. and FX Solutions — who conducted the trading via a "foreign currency exchange" ("forex") market. This forex market, which is central to this case, is not a public market, but is instead a "negotiated market," in which — according to the parties — foreign currency prices (the prices used for the trades in this case) are "constructed" by the FCMs using "software to process and distill currency prices offered by numerous banks and come up with an indicative market price."

In this FCM-created market, the FCMs offered unit-batches of currencies (e.g., 1,000 units or 100,000 units — units being foreign currency, e.g., £, ¥, F_r, 荤, etc.). But unit batches were not mandatory; they were offered only for transactional or bookkeeping convenience. The FCM's customers (e.g., Goros, on behalf of its 20 clients) were not restricted to buying preset batches; a customer could buy or sell currencies in any amounts of its choosing, including odd amounts (e.g., 7, 139, 25640, etc.). Importantly, the trading was in the actual currency, not in any paper representing a fungible unit batch of currency to be bought or sold at a later date.

The FCM's trading agreements stated: "Trader acknowledges that the purchase or sale of a currency always anticipates the accepting or making of delivery." So the actual, written agreement — as opposed to the subjective expectations of Goros, its clients, or any other FCM investor — provided for delivery of the foreign currency to actually occur, typically in accordance with the market convention of one or two days from the transaction (e.g., 48 hours). Of course, neither the investors nor the traders (Goros and the FCMs) actually wanted any foreign currency, so the practice was to roll over the balance every night and push the 48-hour delivery date forward indefinitely.

In carrying this construct (i.e., the imitation foreign currency market) to its logical end, the FCMs satisfied the transactions themselves, as "counter-parties." Goros would place an order (to buy or sell X units of foreign currency) with an FCM and the FCM would accept the order, but the FCM would not actually buy or sell any foreign currency. Instead, the FCM — using its computer-generated estimates of the market price (i.e., from its forex market) — would pretend the order had been filled (and later closed), and record the "transactions" in its system at the listed prices.

B.

At the risk of oversimplifying, an example might be helpful. Let us say that Goros on behalf of a client, Lola, instructs the FCM to purchase 100 Chinese RMBs at $1 per RMB (to be sure, $1 per RMB is just this example's hypothetical price, taken from this example's hypothetical forex market, and has no relation to any real price, actual or forex). The FCM records 100 RMBs in Lola's account (i.e., Lola now "owns" 100 RMBs) and charges her $100,¹ but the FCM never actually purchases any RMBs, it just records "ownership" in her account. Then assume that the very next day the forex market is trading at $1.25 per RMB, so Goros instructs the FCM to sell the 100 RMBs. Again, the FCM doesn't actually "sell" any RMBs (which it never actually purchased), but merely credits Lola's account $125 and deletes the record of 100 RMBs from her account. In the span of a day, Lola has made $25 (less fees), by "trading foreign currency."

This could work the other way, too. Suppose that, on that first day, Goros, on behalf of another client, call him Lyle, instructs the FCM to sell 100 RMBs at $1 per RMB. The FCM records that Lyle "sold" 100 RMBs (which he doesn't have, but will have to "buy" at some point in the future to fulfill his side of the sale — i.e., a "short") and pays him $100, without ever actually selling any RMBs to anyone. But because the forex market trades at $1.25 per RMB the next day, Goros (fearful of further losses if the RMB keeps climbing in price) instructs the FCM to "buy" 100 RMBs and close out the short sale. Again, the FCM doesn't actually buy any RMBs (just as it never actually sold any), but merely evens up Lyle's account by deducting $125 and deleting the sale of the 100 RMBs. In the span of a day, Lyle has lost $25 (plus fees) trading foreign currency.

Notably, all this pretend trading occurred only in the commodity itself (i.e., the RMBs) — no contracts for purchase or sale were ever bought, sold, or traded. Neither Lola nor Lyle ever saw, let alone traded in, any standardized agreement, such as a typical option or futures contract. That is, Lola did not buy the "right to purchase 100 RMBs for $100 at any time before date ___," she just bought the RMBs. And Lyle did not purchase the "right to sell 100 RMBs for $125 at any time before date ___," he simply sold RMBs. Similarly, as there was no trading in any contract, there is no exchange in which such contracts would be traded. Clearly, the forex exchange is not such an exchange, it is a pretend exchange for the underlying commodity — so, as it turns out, there was not even a real exchange for the underlying commodity, there was only the construct used to inform the FCMs on the real-time price (though, it is undisputable that the FCMs could have purchased the foreign currency on the open market). Also, the agreements were not fungible, they were individual — Lola could have purchased any number of RMBs, just as Lyle could have sold any number of RMBs (there was no need, other than to simplify the math, for either transaction to involve exactly 100 RMBs). And the price was dictated by the market at the time of transaction. Finally, there was no designated time for closing the trade. Just as the district court found in the present case, the "transactions differed in price, amount and settlement date, unlike futures contracts where the contract must be liquidated at a fixed date determined at the time of purchase."

C.

The CFTC emphasizes that none of the investors had any personal reason to actually acquire any foreign currency or even the ability to do so. Instead, the rollover provisions were invoked and the trades carried into the future indefinitely. Indeed, no foreign currency was ever actually acquired for any of these investors for any trade. Pointing to this fact — that the investors never actually owned the foreign currency — the CFTC exclaims that the only reason these investors purchased these foreign currencies was to speculate in the price changes. This is all true and undeniable.

Goros moved for summary judgment on the basis that the CFTC has no jurisdiction over "forward contracts." Goros argued that the investors could request and receive the currency, if they so chose, based on the plain language of the Account Opening Agreements, and therefore, these contracts were actually "forward contracts." The CFTC replied that, because the investors had no (subjective) intention of ever receiving any foreign currency, but instead had the ability to offset their positions (as well as buy on margin), these were "futures contracts." The district court, relying on the Seventh Circuit's Zelener decision, see infra, and the plain language of the Account Opening Agreements, agreed with Goros and granted its motion. The CFTC timely appealed.

II.

Prior to 2000, the CFTC had no jurisdiction over off-exchange transactions in foreign currency. In 2000, however, Congress enacted the Commodity Futures Modernization Act amendments to the Commodity Exchange Act (hereafter referred to collectively as the "CEA"), which gave the CFTC jurisdiction over certain foreign exchange transactions, including those involving "futures contracts." The newly amended statute regulates "futures contracts," stating:

This chapter applies to, and the Commission shall have jurisdiction over, an agreement, contract, or transaction in foreign currency that (i) is a contract of sale of a commodity for future delivery . . . and (ii) is offered to, or entered into with, a person that is not an eligible contract participant, unless the...