Klein & Co. Futures, Inc. v. Board of Trade

• Decision Date: 18 September 2006
• Docket Number: Docket No. 05-1662-cv(XAP).,Docket No. 05-1702-cv(XAP).,Docket No. 05-1718-cv(XAP).,Docket No. 05-1374-cv(L).
• Citation: 464 F.3d 255
• Parties: KLEIN & CO. FUTURES, INC., Plaintiff-Appellant-Cross-Appellee, v. BOARD OF TRADE OF the CITY OF NEW YORK, New York Clearing Corporation, Mark D. Fichtel, Albert Weis, Jeff Soman, Charles Sweeney, Al Peres, Chris Meek, George Haase, Lawrence Gulitti, Bryan Sayler, Hitesh Trivedi, New York Cotton Exchange, Inc., New York Futures Exchange, Inc., Joseph O'neill, Walter Fair, Evan Thomas, Joseph Jach, Defendants-Appellees-Cross-Appellants, First West Trading, Inc., and Norman Eisler, Defendants-Cross-Appellants, John Doe 1-10, Richard Roe and Peter Poe, Defendants.
• Court: U.S. Court of Appeals — Second Circuit

464 F.3d 255

KLEIN & CO. FUTURES, INC., Plaintiff-Appellant-Cross-Appellee, v. BOARD OF TRADE OF the CITY OF NEW YORK, New York Clearing Corporation, Mark D. Fichtel, Albert Weis, Jeff Soman, Charles Sweeney, Al Peres, Chris Meek, George Haase, Lawrence Gulitti, Bryan Sayler, Hitesh Trivedi, New York Cotton Exchange, Inc., New York Futures Exchange, Inc., Joseph O'neill, Walter Fair, Evan Thomas, Joseph Jach, Defendants-Appellees-Cross-Appellants First West Trading, Inc., and Norman Eisler, Defendants-Cross-Appellants John Doe 1-10, Richard Roe and Peter Poe, Defendants.

Docket No. 05-1374-cv(L).

Docket No. 05-1662-cv(XAP).

Docket No. 05-1702-cv(XAP).

Docket No. 05-1718-cv(XAP).

United States Court of Appeals, Second Circuit.

Argued: February 3, 2006.

Decided: September 18, 2006.

Jeffrey Plotkin, Pitney Hardin LLP, New York, NY, for Appellant Klein & Co. Futures, Inc.

Gary D. Stumpp, Stumpp & Bond LLP, New York, NY, for Appellees First West Trading, Inc. and Norman Eisler.

Howard R. Hawkins, Jr., Cadwalder, Wickerhsam & Taft LLP, New York, NY, for Appellees Nybot, et al.

Before: POOLER and B.D. PARKER^*, Circuit Judges.

B.D. PARKER, JR., Circuit Judge:

Klein & Co. Futures Inc. is a futures commission merchant ("FCM") and a clearing member of New York Clearing Corporation ("NYCC"). Klein appeals the dismissal by the United States District Court for the Southern District of New York (Daniels, J.) for lack of standing to bring claims against Defendant-Appellees the Board of Trade of the City of New York ("NYBOT"), New York Clearing Corporation ("NYCC"), Norman Eisler, and others (collectively "NYBOT Defendants") under Sections 22(a) and (b) of the Commodity Exchange Act (CEA), 7 U.S.C. § 25. After dismissing Klein's claims under the CEA, the district court declined to exercise jurisdiction over its supplemental state law claims and dismissed them without prejudice. The NYBOT defendants cross-appeal that dismissal. For the reasons set forth below, we affirm. Except as noted, the facts are drawn from the complaint.

As a FCM, Klein facilitated the trading and fulfilled certain obligations of its customers who traded through the NYBOT. Prior to May 2000, Defendant Norman Eisler, whose conduct is the focus of Klein's complaint, was the Chairman of the New York Futures Exchange ("NYFE"). The NYFE is a futures and options exchange designated by the Commodity Futures Trading Commission ("CFTC") as a contract market for the trading of commodities futures and options, including P-Tech Futures and Options ("P-Tech contracts"). Eisler was also a member of the NYFE's Settlement Committee for the Pacific Stock Exchange Technology Index Futures Contract & Options (the "Committee"). The Committee's primary responsibility was to calculate the price of P-Tech contracts for the purposes, among other things, of calculating margin requirements in customers' accounts.¹ Eisler was also a customer of Klein and the principal of First West Trading Inc. ("First West"), another Klein customer. Eisler traded in P-Tech contracts for the account of First West. The trades were unsolicited and were made without input or advice from Klein.

Allegedly, Eisler, in his capacity as a member of the Committee, secretly manipulated the settlement prices of P-Tech contracts.² This manipulation benefitted Eisler's P-Tech positions but, at the same time, caused Klein to miscalculate the margin requirements for the First West account. Around March 2000, the NYBOT began receiving complaints regarding the P-Tech settlement prices but failed to make proper inquiries or to place Klein or other members of the industry or public on notice of potential irregularities.

In early May 2000, Klein, based on the incorrect settlement prices, computed the required margin in First West's account at $700,000, but Eisler was unable to post that amount. Klein then contacted the NYBOT and expressed concerns regarding the illiquidity of the P-Tech contracts, Eisler's inability to meet First West's margin call, and his inability to liquidate First West's contracts. Klein reported that the First West margin deficit, if not covered, would impair Klein's net capital and cause Eisler significant losses. Klein requested that the NYFE Board halt trading in P-Tech contracts, but no such action occurred.

At that point, the scheme began to unravel. In mid-May, Eisler's NYBOT membership privileges were suspended and he was dropped from the Committee. Once this occurred, the remaining Committee members recalculated the settlement prices and First West's margin deficit ballooned to $4.5 million, an obligation it could not meet. As a result, Klein was required to take an immediate charge against its net capital, forcing it below the minimum required for clearing members of the NYCC and the New York Mercantile Exchange ("NYMEX"). Its membership privileges were suspended and Klein collapsed.

Klein then sued on various claims. Klein's first claim alleged that NYFE violated § 5b of the CEA by failing to enforce its rules, and sought a declaration that NYFE should be suspended as a contract market. Klein further alleged that the NYBOT Defendants violated the anti-fraud provisions in CEA § 4b and 17 C.F.R §§ 33.9 and 33. 10, and the insider provisions of CEA § 9. In addition, the complaint alleged a variety of state law claims.

The NYBOT Defendants moved to dismiss principally on the ground that Klein was not a purchaser or seller of futures contracts or options and, therefore, lacked standing under § 22 of the CEA. They also they moved to dismiss Klein's state law claims with prejudice on the ground that they were preempted by the CEA. The district court agreed and dismissed Klein's claims under the CEA for lack of standing. Specifically, the district court concluded:

Plaintiff Klein lacks standing under Section 22 to bring this suit. Klein does not allege that it was either a purchaser or a seller of P-Tech Futures and Options. Furthermore, Klein does not claim that it traded for its own account. Rather, it is undisputed that First West, not Klein, traded in P-Tech Futures and Options. Indeed, Klein claims that these trades were effected "without input, counsel, advice or any type of recommendation whatsoever from Klein & Co." Klein further alleges that it "had no equity or financial interest in the First West account nor did Klein & Co. exercise control over the trade in said account."

Klein & Co.Futures. v. Bd. of Trade, No. 00-CV-5563-GBD, 2005 WL 427713, at *4 (S.D.N.Y. Feb. 18, 2005 (internal citations omitted)).

The court further reasoned that § 22 precluded an action by a plaintiff that "did not suffer its damages in the course of its trading activities on a contract market." Id. Without addressing preemption, the district court declined to exercise supplemental jurisdiction over the state law claims and dismissed them without prejudice. This appeal followed.

II. DISCUSSION

We review de novo the district court's dismissal of a complaint for lack of standing under Fed.R.Civ.P. 12(b)(1) and 12(b)(6). See Kaliski v. Bacot (In re Bank of N.Y. Deriv. Litig.), 320 F.3d 291, 297 (2d Cir.2003). We review the court's decision to decline supplemental jurisdiction over state law claims for abuse of discretion. See Valencia ex rel Franco v. Lee, 316 F.3d 299, 304 (2d Cir.2003).

A. Standing under § 22 of the CEA

CEA § 22 enumerates the only circumstances under which a private litigant may assert a private right of action for violations of the CEA. Section 22 includes two types of claims. Section 22(a) relates to claims against persons other than registered entities and registered futures associations. 7 U.S.C. § 25(a).³ Section 22(b) deals with claims against those entities and their officers directors, governors, committee members and employees. The text of the two subdivisions requires that a putative plaintiff fall within one of the four required relationships set forth in § 22(a)(1)(A-D).

The common thread of these four subdivisions is that they limit claims to those of a plaintiff who actually traded in the commodities market. Specifically, the remedies afforded by CEA § 22(b) are available only to a private litigant "who engaged in . . . transaction[s] on or subject to the rules of" a contract market. Id. § 25(b)(1)-(3).⁴ The section contains another important limitation. Subsection 22(b)(5) provides that the private rights of action against the exchanges enumerated in § 22(b) "shall be the exclusive remedy . . . available to any person who sustains a loss as a result of" a violation of the CEA or an exchange rule by a contract market or one of its officers or employees. Id. § 25(b)(5) (emphasis added).

Klein does not fall within any of the required subdivisions of § 22(a)(1)(A)-(D). To fit under one of the four, Klein must essentially either have (1) received trading advice from Eisler or First West for a fee; (2) traded through Eisler or First West or deposited money in connection with a trade; (3) purchased from or sold to Eisler or First West or placed an order for the purchase or sale through them; or (4) engaged in certain market manipulation activities in connection with the purchase or sale of a commodity contract.

Here, Klein was a FCM and a clearing member of the NYCC that cleared First West's trades through NYCC. Klein does not contend that it purchased or sold P-Tech contracts. Klein was not a trader of P-Tech contracts; nor did it own the P-Tech contracts at issue. To the contrary, Klein's complaint admits that it had no financial interest in the First West account and that all the trades in question were unsolicited by First West. Klein's losses were not the result of its purchases or sales in the commodities market. Klein functioned merely as a broker or agent that earned commissions for handling its customers trades. As a clearing member, Klein cleared their trades and was obligated to post margins for them as required. Under NYCC Rules governing...