Curran v. Merrill Lynch, Pierce, Fenner and Smith, Inc.

• Decision Date: 12 May 1980
• Docket Number: No. 77-1300,77-1300
• Citation: 622 F.2d 216
• Parties: Fed. Sec. L. Rep. P 97,390 J. J. CURRAN and Jacquelyn L. Curran, Individually and as trustees of the John J. Curran Living Trust and Jacquelyn L. Curran Living Trust, Plaintiffs- Appellants, v. MERRILL LYNCH, PIERCE, FENNER AND SMITH, INC., Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 216

622 F.2d 216

Fed. Sec. L. Rep. P 97,390

J. J. CURRAN and Jacquelyn L. Curran, Individually and as trustees of the John J. Curran Living Trust and Jacquelyn L. Curran Living Trust, Plaintiffs- Appellants, v. MERRILL LYNCH, PIERCE, FENNER AND SMITH, INC., Defendant-Appellee.

No. 77-1300.

United States Court of Appeals, Sixth Circuit.

Argued April 19, 1979.

Decided May 12, 1980.

Robert A. Hudson, John W. Callahan, Detroit, Mich., for plaintiffs-appellants.

Douglas G. Graham, Richard P. Saslow, Butzel, Keidan, Sinion, Myers & Graham, Detroit, Mich., for defendant-appellee.

Before LIVELY and ENGEL, Circuit Judges and PHILLIPS, Senior Circuit Judge.

ENGEL, Circuit Judge.

Plaintiffs appeal from the district court's order granting partial summary judgment in favor of the defendant Merrill Lynch, Pierce, Fenner & Smith (hereinafter Merrill Lynch), and further granting Merrill Lynch's motion for stay of the remaining claims pending arbitration. ¹

In their complaint, plaintiffs John J. Curran and Jacquelyn L. Curran sought damages from Merrill Lynch for false representations made by its agents which induced plaintiffs to open discretionary commodity trading accounts with Merrill Lynch and for the broker's subsequent mismanagement of those accounts.

Specifically, plaintiffs allege that the accounts constitute investment contracts under federal law, and that Merrill Lynch violated Section 5 and Section 12(2) of the Securities Act by failing to file a registration statement before making an offer and sale of a security. Plaintiffs also assert that defendant made untrue statements of material fact, omitted to state material facts necessary to make the statements not misleading, and employed a device, scheme, or artifice which operated as a fraud upon plaintiffs, all in violation of Rule 10b-5, § 17(a) of the Securities Act, § 6(a) of the Commodities Exchange Act, § 410(a)(2) of the Michigan Uniform Securities Act, and principles of common law. Plaintiffs further allege that defendant breached the commodity account agreement by: (1) failure to manage the accounts in a skillful and prudent manner; (2) failure to observe certain safeguards and stop-loss limits; and (3) failure to employ a scientific and comprehensive investment plan and instead, engaging in reckless and haphazard trading with the sole intention of generating large commissions.

The district court ruling presents several issues of first impression in this circuit. Initially, we must determine whether a discretionary trading account in commodity futures constitutes a "security" subject to the registration requirements and enforcement provisions of the federal securities laws. The court below determined the account was not a security and entered partial summary judgment against plaintiffs' securities claims, relying primarily on Milnarik v. M-S Commodities, Inc., 457 F.2d 274 (7th Cir.), cert. denied, 409 U.S. 887, 93 S.Ct. 113, 34 L.Ed.2d 144 (1972). In Milinarik the Seventh Circuit, speaking through Mr. Justice Stevens (then Judge Stevens), held that a discretionary trading account in commodity futures is not a security because such accounts lack the "common enterprise" element required for an investment contract under Securities Exchange Commission v. Howey, 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946). We agree.

Further, we reject plaintiffs' contention that the account involved here, though not a security, should be treated as such because it was fraudulently misrepresented to include the essential elements of a common enterprise.

This appeal also presents substantial questions whether the district court should have stayed plaintiffs' other claims pending arbitration, and whether in all events the lawsuit is barred by a one-year limitation period provided for in the contract in question. Finally, for reasons set forth later, we have been obliged to consider, sua sponte, and have determined that an implied private right of action exists under the Commodity Exchange Act. ²

I. FACTS

Plaintiffs, as customers of the broker-dealer defendant, Merrill Lynch, lost a substantial sum of money in the highly volatile and speculative futures market. These losses were allegedly sustained due to Merrill Lynch's mismanagement of plaintiffs' discretionary commodity accounts in a manner contrary to representations made when the contracts were made.

In 1973, plaintiffs opened several accounts for trading commodity futures in defendant's "Guided Commodities Account Program." In the written Customer Plaintiffs allege that Merrill Lynch fraudulently misrepresented how the account would be handled with respect to other accounts in the same program. They insist that the discretionary account was represented to involve several unique elements in that: (1) the program involved a specified number of investors who could not withdraw their capital for a minimum of 18 months; (2) the accounts were to be controlled by an individual trader who could direct buy/sell decisions on a broad basis and thereby control fluctuations in the market; (3) the capital availability and buying power generated by control over the group of accounts would create a multibuyer effect allowing the trader to buy as though he were buying five times greater the amount than if dealing with a separate account.

Account Agreement, the parties agreed to submit any dispute under the contract to arbitration within one year after the accrual of such claim. As Merrill Lynch interprets the program, a customer deposits an amount he is prepared to risk in his own commodity trading account. Merrill Lynch further claims that although specific recommendations for purchase and sale are made by commodities specialists, the ultimate decision to act or not is made only upon the customer's direct order. However, plaintiffs have raised a question of fact with respect to that issue in the pleadings and Merrill Lynch has acknowledged that, for purposes of this appeal only, the plaintiffs' commodity trading accounts must be deemed discretionary, with trading control in the hands of Merrill Lynch.

To support these contentions, plaintiffs state that after they opened the first account of $100,000 Merrill Lynch made all trading decisions and exercised complete control over plaintiffs' accounts. Initially, plaintiffs realized profits on the trading activity and at one point withdrew $101,007.80. Later, the accounts declined in value and plaintiffs suffered excessive trading losses which they blame upon improper and excessive trading activities and a failure to observe the "stop loss" procedures represented to exist as part of the program. On several occasions, plaintiff John J. Curran requested that the accounts be closed and that plaintiffs be "cashed-out." On each occasion, except the final one (at which time plaintiffs' capital had been reduced to approximately $6,000), defendant either refused to follow his advice or convinced Curran that he was required to stay in the program for 18 months. In April, 1974, the defendants assented to plaintiffs' demands to "cash-out" the accounts. At that time plaintiffs assert that the accounts had declined in value approximately $175,000. Significantly, Merrill Lynch had in the meanwhile been paid $44,500 in commissions.

II.

A commodity future is a standardized contract for the purchase and sale of a fixed quantity of a commodity to be delivered in a specified future month at a price agreed upon when the contract is entered into. See generally Bromberg, Securities Laws § 4.6, at 82.181 (1975). Futures contracts are traded by futures commission merchants and floor brokers on national exchanges, or "contract markets," which are regulated by the Commodity Futures Trading Commission (CFTC).

Generally, a futures contract seller is characterized as being in a "short" position since he must deliver the commodity in accordance with the contract in order to receive the purchase price. The purchaser of a futures contract is labeled as holding a "long" position in that he must pay the contract price before receiving the commodity. Ordinarily, the number of trades far exceeds the number of actual deliveries since futures contracts are the subject of speculation by traders seeking to profit from their trading acumen, rather than from actually delivering or receiving the commodity involved. As Judge Kinneary stated in Berman v. Bache, Halsey, Stuart, Shields, Inc., 467 F.Supp. 311, 315-16 (S.D.Ohio 1979), "a commodities future contract is little more than a wager that the market price of a given commodity will change in a Although bare commodities are generally not considered securities, some courts have determined that an investment contract is formed when commodity accounts are managed by the seller or affiliate. ³ Typically, a customer trading in a discretionary commodity account gives the broker authority to buy and sell at the broker's discretion, without prior consultation with the customer. Discretionary accounts are more common for commodities where fast trading is required due to sharp movement in prices, a factor further magnified by the high leverage that results from generally low margin requirements.

given direction by a specified future date." Normally, the trader's expectation of profit arises solely from speculative hope based upon his expertise in the market.

While the underlying commodities themselves do not constitute securities, whether a discretionary commodity account constitutes an investment contract, and thus a security under the federal securities laws, is a current topic of dispute in the federal courts. The question is particularly difficult where there is no actual pooling of the customer's funds with those of other investors.

Whether a particular financial arrangement is considered an "investment contract," ⁴ and therefore subject to the filing requirements of Section 5, Securities Act of 1933, and the antifraud provisions of Section 10 and Rule...