Craig v. Refco, Inc., 84 C 10900

• Decision Date: 20 December 1985
• Docket Number: No. 84 C 10900,85 C 4335 and 85 C 0577.,84 C 10900
• Citation: 624 F. Supp. 944
• Parties: William A. CRAIG, individually and on behalf of those similarly situated, Plaintiff, v. REFCO, INC., an Illinois corporation, Merrill Lynch Futures, Inc., a foreign corporation, Clayton Brokerage Company of St. Louis, a foreign corporation, and the Futures Discount Group, Inc., an Illinois corporation, Defendants.
• Court: U.S. District Court — Northern District of Illinois

624 F. Supp. 944

William A. CRAIG, individually and on behalf of those similarly situated, Plaintiff, v. REFCO, INC., an Illinois corporation, Merrill Lynch Futures, Inc., a foreign corporation, Clayton Brokerage Company of St. Louis, a foreign corporation, and the Futures Discount Group, Inc., an Illinois corporation, Defendants.

Nos. 84 C 10900, 85 C 4335 and 85 C 0577.

United States District Court, N.D. Illinois, E.D.

December 20, 1985.

Robert A. Holstein, Holstein, Mack and Assoc., Chicago, Ill., for plaintiff.

Thomas P. Luning, Susan R. Lichtenstein, David M. Mason, Schiff, Hardin & Waite, Chicago, Ill., for defendant Refco.

MEMORANDUM AND ORDER

MORAN, District Judge.

As an investor in the commodities market, plaintiff challenges his futures contract brokers' practice of retaining the interest made by investing plaintiff's margin funds. Plaintiff claims that because section 4(d) of the Commodity Exchange Act (the Act), 7 U.S.C. § 6d, treats such money as belonging to the customer, any interest accrued on such money also belongs to the customer. Defendants argue that while plaintiff's argument sounds logical, it is contrary to congressional intent. They have moved for dismissal under Rule 12(b)(6) of the Federal Rules of Civil Procedure, on the ground that their interpretation of the Act precludes plaintiff's claims. Because the Act has been definitively interpreted as supporting defendants' views, the court grants defendants' motion as to plaintiff's claims based on 7 U.S.C. § 6d.

I.

Because commodities futures contracts are executory contracts representing a promise to deliver or buy commodities in the future, there is always a risk that when the contract comes due the buyer or seller will default. To protect both parties, each must deposit with the futures contract broker (known as futures commission merchants or FCM) money which serves as a performance bond or earnest money and is called "a margin." The margin serves to protect the broker, as well as the customer, because Exchange rules require the FCM to bear any trading losses not honored by its customers. P.M. Johnson, Commodities Regulation, § 1.10 at 32 (1982).¹ Because of the short-term nature of the risk of default the margin must be extremely liquid. It is usually in the form of cash.

The Act regulates brokers' handling of margins. Section 4d(2) of the Act, 7 U.S.C. § 6d(2), mandates, inter alia, that FCMs treat and deal with all funds and property received by them to margin, guarantee or secure trades or contracts, or accruing as the result of trades or contracts, as the property of the customer. Customer funds and property within the meaning of § 4d(2) must be separately accounted for and may not be commingled with the FCM's own funds or used to margin the trades of or extend credit to any other person. However, this same section allows but does not require FCMs to invest these funds in certain (highly liquid) obligations.²

The regulations which correspond to § 4d(2) detail this basic framework. FCMs may invest in obligations specified in § 4d(2) (Regulation 1.25), they must segregate and separately account for such obligations (Regulation 1.26), and they must maintain detailed records concerning such investments (Regulation 1.27). Under Regulations 1.28 and 1.29, FCMs who invest customer funds in authorized obligations bear the risk of any decline in the value of such obligations and may retain any "increment" and "interest" received on such investments. Regulation 1.29 specifically states:

The investment of customer funds and obligations described in section 1.25 shall not prevent the futures commission merchant or clearing organization so investing such funds from receiving and retaining as its own any increment or interest resulting therefrom.

17 C.F.R. § 1.29 (1985). It is this regulation which plaintiff claims flatly contradicts, and is, therefore, an erroneous application of § 4d(2)'s mandate that brokers will handle margins "as belonging to the customer."

II.

Before analyzing plaintiff's arguments the court notes that it is unclear from his pleadings and briefs what exactly he thinks is illegal conduct. Craig's complaint seems to say that FCMs act illegally when they retain interest made on any margin money of the customers (count I, ¶ 24). However, in his memorandum in opposition to Refco's motion to dismiss the amended complaint, Craig claims a right only to the interest on the surplus margin which remains after the FCM has paid the margin required by the Exchange. Because no such distinction exists in the Act or its regulations, and plaintiff has given no reasonable basis for splitting up the margin into different categories and treating each sum differently, the court refuses to accept plaintiff's distinction. Plaintiff's arguments will be discussed in terms of all the funds received by an FCM from the customer, including the initial margin and any adjustments made to it due to profits or losses.

Plaintiff's basic argument is that by enacting Regulation 1.29 the Commodity Futures Trading Commission (CFTC)³ erroneously interpreted the Act, contradicting its mandate that FCMs treat margin as belonging to the customer. His argument is one of congressional intent. Only when such intent cannot be divined from legislative history or congressional actions (using traditional tools of statutory construction) is it necessary to construct Congress' intent indirectly by analyzing administrative interpretations of the statute. Chevron, U.S.A. v. Natural Resources Defense Council, 467 U.S. 837, 104 S.Ct. 2778, 2781-82, 81 L.Ed.2d 694 (1984).

For his argument, plaintiff Craig cites various supporting rules of statutory construction in his initial brief, including the "plain language rule," the rule that "no clause, sentence or word should be rendered void or contradictory," and the rule that "a statute is to be given reasonable construction." Unfortunately, Craig does not address the legislative history of the Act, which clearly authorizes the practice described in Regulation 1.29 and which no amount of statutory construction can deny.

In 1936 Congress was concerned with FCMs' practice of using customer margin funds to satisfy their own debts or to extend credit to other customers. As Senator Pope said:

Margin deposits have been intermingled with the funds of these futures commission merchants, and have been used by them in the conduct of their own business. They have not been held intact for the benefit of the traders. It further appears that certain favored dealers have not been required actually to put up the money for margins and have been extended credit in that respect. This gives these favored dealers an advantage. In some instances large commission firms have become bankrupt and the funds placed with them by a large number of dealers were lost.

80 Cong.Rec. 6162 (1936).

The House solution was to prevent FCMs from using margin money at all for any purpose. 79 Cong.Rec. 8587 (1935). The Senate felt that this was too harsh:

A third question has been raised as to the proviso in subsection 2 of section 4(d) ... which refers to moneys deposited with commission merchants for margins. It is provided in the bill that these moneys must be deposited by the commission merchant with a bank or trust company or clearing house organization. It is pointed out that such commission merchants ought to have the right to invest this money in good securities. This seems a valid criticism of the bill.

The grain futures administration believes that such investments may properly be made but should be limited to investment securities of national banks, as defined in and under authority of section 5136 of the revised statutes of the United States, as amended.... It would rule out questionable paper in which many State banks are now permitted to invest their capital....

80 Cong.Rec. 6612-13 (1936) (remarks of Senator Pope). The Senate adopted the agency's suggestions and § 4d(2) was amended. The amendment was to "provide some limitation under which the commission men may use customer funds to invest" while rectifying "the evils which have heretofore existed in relation to the investment of money coming from clients...." 80 Cong.Rec. 7911 (1936) (remarks of Senator Norris).

The senators' language and purpose directly supports Regulation 1.29, when read with Regulations 1.25 through 1.28. Congress wanted to ensure that customers' margin funds did not disappear. Regulations 1.25 ensures this by requiring FCMs to maintain at all times funds equivalent to the present market value of the margin deposited by the customer. Because of this requirement the FCM must compensate for any decline in the value of an obligation purchased with customer funds by adding his own funds to the segregated account. Hence the FCM, not the customer, bears the risk of any decline in the value of investments purchased with customer funds. Conversely, Regulation 1.29 recognizes that FCMs may retain the profits received on such investments. Plaintiff argues that this scheme fails because

if the FCM purchases Treasury bills with the customer's margin deposits the FCM receives interest earned, but if the customer, instead of depositing cash, purchases T-bills himself (and uses those as his margin deposit), he receives the interest earned.

(Plaintiff's answering memorandum in opposition to defendants' and amici memorandum in support of a motion to dismiss, p. 2).

Plaintiff misses a key point in his argument: the customer who gives an FCM a T-bill as margin, instead of cash, may gain from the T-bill, but he or she is also bearing the risk of a decrease in the instrument's value. The Act's scheme, framed in its regulations, is simply a codification of the basic proposition that he or she who bears the risk should also receive the benefit from such risk. By its language Congress clearly intended to incorporate this proposition into § 4d of the Act. The Act restricts...