Kelley v. Carr, G77-550 C.A.

• Decision Date: 05 December 1977
• Docket Number: No. G77-550 C.A.,G77-550 C.A.
• Citation: 442 F. Supp. 346
• Parties: Frank J. KELLEY, Attorney General of the State of Michigan, Plaintiff, Commodity Futures Trading Commission, Intervening Plaintiff, v. James A. CARR and Charles P. LeMieux, III d/b/a Lloyd, Carr & Co., a partnership, James A. Carr and Charles P. LeMieux, III d/b/a Lloyd Carr Financial Co., a partnership, James A. Carr, and Charles P. LeMieux, III, Defendants.
• Court: U.S. District Court — Western District of Michigan

442 F. Supp. 346

Frank J. KELLEY, Attorney General of the State of Michigan, Plaintiff, Commodity Futures Trading Commission, Intervening Plaintiff, v. James A. CARR and Charles P. LeMieux, III d/b/a Lloyd, Carr & Co., a partnership, James A. Carr and Charles P. LeMieux, III d/b/a Lloyd Carr Financial Co., a partnership, James A. Carr, and Charles P. LeMieux, III, Defendants.

No. G77-550 C.A.

United States District Court, W. D. Michigan, S. D.

December 5, 1977.

Frank J. Kelley, Atty. Gen. by Marc A. Goldman, Asst. Atty. Gen., Lansing, Mich., for plaintiff.

Robert A. W. Boraks, Washington, D. C., for intervening plaintiff.

Bushnell, Gage & Reizen, Detroit, Mich., Noel A. Gage, Detroit, Mich., of counsel, for defendants.

OPINION

FOX, Chief Judge.

This case was initiated by the Attorney General of Michigan in the Circuit Court for Ingham County. It was alleged that defendants were in violation of various sections of both the Michigan Uniform Securities Act, M.C.L.A. §§ 451.501 et seq. (1977), and the Michigan Consumer Protection Act, M.C.L.A. §§ 445.901 et seq. (1977) by transacting business as unregistered commodities broker-dealers and agents, transacting business fraudulently, and offering and selling unregistered securities. Plaintiff subsequently amended his complaint to allege violations of the anti-fraud provisions of the federal Commodity Exchange Act, 7 U.S.C. §§ 1 et seq. (1977). Defendant Lloyd, Carr & Co. petitioned this court for removal of the action from the state court. The Commodity Futures Trading Commission (C.F.T.C.) then moved to intervene as a party plaintiff.

On November 7, 1977, I issued a temporary restraining order basically enjoining defendants from engaging in any sort of fraudulent or deceitful business activities. I also granted the C.F.T.C.'s motion to intervene. The matter is now here on motions by plaintiffs for preliminary injunctive relief.

Lloyd, Carr & Co. and Lloyd Carr Financial Co. were both founded in mid-1976, and are now partnerships between James A. Carr and Charles P. LeMieux, III. Lloyd, Carr & Co. engages in the business of soliciting and selling so-called London commodity options¹ on futures contracts. Lloyd Carr Financial is a commodity trading advisor; that is, it "engages in the business of advising others either directly or through publications or writings, as to the value of commodities or as to the advisability of trading in any commodity . . .."² On August 1, 1977, the C.F.T.C. issued an opinion in an administrative proceeding instituted against Lloyd, Carr in early 1977. The Commission ruled that Lloyd, Carr was engaged in the business of selling and offering to sell commodity futures options without proper registration under federal regulations. It revoked the existing registration of Lloyd Carr Financial as a commodity trading advisor, denied the application for registration of Lloyd, Carr & Co. as a futures commission merchant, and entered a cease and desist order barring further violations of the Commodity Exchange Act. Lloyd, Carr appealed that ruling to the Second Circuit Court of Appeals, which stayed enforcement pending its determination.

Lloyd, Carr has its principal place of business in Boston, and has offices in several cities across the country, including one in Detroit. Activities in the Detroit office led to the initiation of this action by the Attorney General of Michigan, although plaintiff C.F.T.C. alleges unlawful activities in all Lloyd, Carr operations.

A futures contract is an agreement to purchase or sell a fixed amount of a commodity³ of a certain grade at a certain future date for a fixed price. Futures contracts may be settled by delivery of the goods, but in the vast majority of cases an offsetting transaction occurs in which the holder of a contract to sell liquidates his position by purchasing a contract to buy the same commodity or the holder of a contract to buy cancels his position by acquiring a contract to sell. An option on a futures contract is a right to buy or sell the contract for a particular commodity at a specified price, known as the "strike price," within a specified period of time. The purchaser pays a premium for the option in addition to broker's fees at the time of purchase and, if the option is exercised, at the time of sale. Options may be supported by an underlying futures contract at the time of their creation. Increasingly, however, so-called "naked options" are being sold. This type of option is one created without backing by either futures contracts or actual ownership of the commodities involved, and may be written by anyone willing to risk that he will be able to cover his obligation should the option be exercised.

It is evident that options are attractive to sellers in that capital requirements are minimal, and to buyers because costs are usually somewhat lower than purchasing a futures contract outright since the premium and initial broker's fees should run less than the margin requirements of the underlying contract, and investors can limit their potential losses. Owing to the ease of market entry, however, fly-by-night organizations are often attracted.

The potential for abuse in the field of option trading created a great deal of pressure for legislation outlawing fraudulent dealings in commodity options. The Commodity Exchange Act, passed in 1936, banned option trading in all domestic commodities within its scope. International commodities, such as those traded on the London exchanges, were not covered, however. In 1974 Congress responded by passing the Commodity Futures Trading Commission Act, which created the C.F.T.C. as an independent regulatory body paralleling the Securities and Exchange Commission and broadened the coverage of the 1936 Act. The 1974 Act amended Section 6c(b) to provide that the C.F.T.C. should have broad authority to regulate, through its rule-making powers, commodity options transactions.⁴ Pursuant thereto, the C.F.T.C. adopted Rule 32.9, which states that:

"It shall be unlawful for any person directly or indirectly —

(a) To cheat or defraud or attempt to cheat or defraud any other person;

(b) To make or cause to be made to any other person any false report or statement thereof or cause to be entered for any person any false record thereof;

(c) To deceive or attempt to deceive any other person by any means whatsoever;

in or in connection with an offer to enter into, the entry into, or the confirmation of the execution of, any commodity option transaction." 17 CFR § 32.9.

Plaintiffs allege that this provision has been violated by defendants. I conclude that the affidavits, exhibits, and testimony produced by plaintiffs clearly show that "the defendants purposefully engaged in the sort of continuous, concerted fraudulent practices that lie at the core of the prohibitions contained in Rule 32.9." Commodity Futures Trading Comm'n v. Crown Colony Commodity Options, Ltd., 434 F.Supp. 911, 914-15 (S.D.N.Y.1977).

I. FINDINGS OF FACT.

It is charged by plaintiffs that Lloyd, Carr has engaged in a high-pressure "boiler room" sales campaign in its efforts to sell commodity options.⁵ The supporting evidence creates a picture of an operation that has no place in an industry where "it is essential . . . that the highest ethical standards prevail . . .."⁶ Defendants have responded by asserting that no "boiler room" exists since Lloyd, Carr rents space in fashionable buildings and conducts its business in well-appointed offices. They have not denied that they offer options "in large volume by means of an intensive selling campaign through numerous salesmen by telephone" without regard to the suitability to the needs of the customer. See note 5, supra. All that really appears to have happened is that the boiler room has been moved to the executive suite.

The first step in Lloyd, Carr's marketing program is the recruitment of sales personnel. In order to attract salespersons, advertisements soliciting applicants are placed in the daily newspapers in the cities where Lloyd, Carr has, or intends to open, offices. These advertisements state that "almost all of our sales people came to us from other industries with neither experience in nor knowledge of commodities as investment vehicle . . .. Income in the upper half of this group, . . ., ranges from $24,000 to $138,000 on an annual basis." The ads also indicate that salespersons receive intensive training. It is clear that Lloyd, Carr sales personnel have no background in the commodity options industry; the ads themselves provide sufficient support for that proposition. It is equally evident from the record before me, however, that despite its representation to the contrary, Lloyd, Carr fails to give salespersons adequate training concerning London commodity options before permitting them to solicit funds from prospective investors for option purchases and to advise investors as to the suitability of such investments.

The "intensive training" that Lloyd, Carr provides does not fully educate the newly-hired individual in the intricacies of the commodity industry. Rather, the training received is primarily in telephone sales techniques. The emphasis is on pressuring potential investors into purchasing. Scripts of "canned" sales pitches are often distributed to sales personnel and they are instructed to maintain control of the conversation at all times.⁷

This type of sales technique is known as a "cold calling" or "cold canvassing" approach. Salespersons make their calls to potential investors with whom neither they nor the company has had prior contacts. Names are collected from lists purchased from commercial customer list firms. After the initial, or "set-up" call, sales personnel begin a series of follow-up calls to pressure their potential client into buying an option. The evidence indicates that some people received daily calls for a month or more. The total number of calls made by Lloyd, Carr's salespersons is...