Lachmund v. Adm Inv. Serv.

• Decision Date: 13 September 1999
• Docket Number: No. 98-3467,98-3467
• Parties: (7th Cir. 1999) TOM LACHMUND, Plaintiff-Appellant, v. ADM INVESTOR SERVICES, INCORPORATED, a Delaware Corporation, A/C TRADING COMPANY, an Indiana general partnership doing business as A/C TRADING 2000, and DEMETER INCORPORATED, an Indiana corporation, Defendants-Appellees
• Court: U.S. Court of Appeals — Seventh Circuit

Page 777

191 F.3d 777 (7th Cir. 1999)

TOM LACHMUND, Plaintiff-Appellant, v. ADM INVESTOR SERVICES, INCORPORATED, a Delaware Corporation, A/C TRADING COMPANY, an Indiana general partnership doing business as A/C TRADING 2000, and DEMETER INCORPORATED, an Indiana corporation, Defendants-Appellees.

No. 98-3467

United States Court of Appeals, Seventh Circuit

Argued February 23, 1999

Decided September 13, 1999

Appeal from the United States District Court for the Northern District of Indiana, Hammond Division. No. 97 C 92--James T. Moody, Judge. [Copyrighted Material Omitted]

Before COFFEY, RIPPLE and ROVNER, Circuit Judges.

RIPPLE, Circuit Judge.

Tom Lachmund brought this action against three businesses under the Commodity Exchange Act ("CEA"), the Racketeering Influenced and Corrupt Organizations Act ("RICO"), and state law. He alleged a conspiracy of fraudulent misrepresentation with respect to certain contracts for the sale of grain. Pursuant to Rule 12(b)(6), the district court dismissed Mr. Lachmund's federal claims in their entirety and the state law fraud claim with respect to one of the defendants. The court declined to retain supplemental jurisdiction over the remaining state law claims. Mr. Lachmund now seeks review of the Rule 12(b)(6) dismissals. For the reasons set forth in the following opinion, we affirm the judgment of the district court.

I BACKGROUND

A. Hedge-to-Arrive Contracts

A hedge-to-arrive contract ("HTA") is an agreement between a farmer and a grain elevator for the sale of a fixed quantity of grain for delivery at a specific time in the future. The parties agree to a price per bushel set by reference to the Chicago Board of Trade ("CBOT") futures price for a particular month, plus or minus a basis (an adjustment that reflects local variables, such as the cost of transportation, storage, labor, and utilities). The futures reference price is fixed at the time of contracting, but the basis floats until the farmer decides to fix it, sometime before an agreed upon pricing deadline. If the farmer does not fix the basis within the specified time, it will be set automatically by the terms of the HTA. See Eby v. Producers Co-op, Inc., 959 F. Supp. 428, 430 n.1 (W.D. Mich. 1997); Farmers Co- op. Co. v. Lambert, No. LACV305569, 1999 WL 177473, at *3 (Iowa Dist. Ct. 1999); Matthew J. Cole, Note, Hedge-To-Arrive Contracts: The Second Chapter of the Farm Crisis, 1 Drake J. Agric. L. 243, 246 (1996).

HTA contracts benefit farmers by permitting them to lock in a particular price and to guarantee themselves a buyer for their grain prior to delivery. They face a risk, however, that grain prices will rise and that they will be committed to selling their grain at an agreed price below the current market value. By the same token, the elevator faces a risk that the futures reference price will fall, leaving the elevator locked into a price above the current market price. Each party can hedge against these risks by establishing a position in the futures market that is opposite to its contract position. For example, the elevator would hedge its risk when it contracts with a farmer by simultaneously establishing a "short" position (an obligation to sell) in the futures market for the month of delivery to offset its obligation to buy from the farmer. See Eby, 959 F. Supp at 430 n.1; Lambert, 1999 WL 177473, at *4; Cole, supra, at 246.

Some HTA contracts (or the parties' practice under such contracts) allow the farmer to "roll" the delivery obligation to some future date, either to accommodate shortfalls in the crop yield or to allow the farmer to sell the grain on the "spot" (cash) market for a better price. When a farmer opts to roll an HTA to a later month, the elevator cancels or offsets its futures hedge in the original delivery month (by entering an obligation to buy the same quantity that it is obligated to sell) and then rehedges by establishing a new short position in the new delivery month. The price difference, as of the date of the roll, between the new and old futures months--the "spread"--is then added to the price per bushel of the original HTA. The farmer thus absorbs this spread, whether it is positive or negative. See Eby, 959 F. Supp. at 430 n.1; Lambert, 1999 WL 177473, at *4-5; Cole, supra, at 250.

B. Facts Pertaining to Mr. Lachmund's Claims

ADM Investor Services, Inc. ("ADMIS") is a corporation registered with the Commodity Futures Trading Commission ("CFTC") as a Futures Commission Merchant. A/C Trading Co. ("A/C") is an Indiana general partnership registered with the CFTC as an Introducing Broker ("IB").¹ A/C Trading 2000 ("A/C 2000") is an Indiana general partnership run by James Gerlach and engaged in the business of agricultural consulting. Demeter, Inc. ("Demeter") is a corporation operating a grain elevator. Plaintiff Tom Lachmund is an Indiana farmer.

In January 1995, Mr. Lachmund entered into a consulting agreement with A/C 2000. Pursuant to A/C 2000's (Gerlach's) advice and consultation, Mr. Lachmund opened a commodity futures and options trading account with ADMIS and entered into a series of HTA grain contracts with Demeter for the sale of Mr. Lachmund's estimated annual yield in 1995 and 1996.² He also purchased some off-exchange options directly from Demeter in 1995 and conducted some options transactions in his ADMIS account in 1996 to hedge against loss on the HTA contracts.

When Mr. Lachmund's crop yield fell short of the contract amounts, he was able to roll the undelivered amounts forward to later crop futures months, even to the next crop year. After a series of rolls, however, Demeter informed Mr. Lachmund in 1996 that it would no longer allow HTA contracts to be rolled beyond the end of a crop year so that each HTA contract had to be settled at the end of the crop year, either by delivery of grain or by cash transaction. Demeter then charged Mr. Lachmund's account with a debit of $304,597.26. Meanwhile, the options Mr. Lachmund had purchased failed to buffer his losses on the HTA contracts.

Mr. Lachmund brought this action under the CEA, RICO, and state law, alleging a conspiracy of fraudulent misrepresentation with respect to his contracts with Demeter. In his complaint, Mr. Lachmund claims that ADMIS, A/C, and other entities conspired to evade the CFTC's futures market regulations by engaging in off-exchange futures market activities through HTA contracts with farmers. The purpose of this alleged conspiracy, according to Mr. Lachmund, was to attract business to ADMIS and its IBs by misrepresenting the HTA contracts as a risk-free method of selling future crops. The HTA contracts were in fact, Mr. Lachmund claims, illegal off- exchange futures contracts because the grain purportedly sold by the contracts did not have to be delivered within the crop year. That the purpose of the contracts was not to transfer actual grain, he alleges, is evidenced by the fact that farmers were encouraged to enter into HTAs for grain quantities greater than they could produce in a crop year, that many HTAs did not specify a delivery date, that the farmers could engage in unlimited rolling of their delivery obligations, and that the contracts could be settled by a cash buy-out at any time.

Mr. Lachmund claims that Gerlach failed to inform him of various material facts concerning the risks involved in the contracts and options program. He claims that Gerlach falsely led him to believe that the only risk would be the price of the options purchased to hedge against the risk of price movement between the time of contracting and the time of delivery. Gerlach failed to inform him of the risk of unlimited liability for inverse crop year spreads in a program in which shortfalls are rolled into the next year. Had the defendants informed him of the actual risks associated with the HTA contracts, Mr. Lachmund asserts, he would not have entered into the contracts, and he would not have opened a trading account with ADMIS.

C. Holding of the District Court

The district court granted the defendants' motions to dismiss Mr. Lachmund's RICO and CEA claims and his state law fraud claim against ADMIS.³ The district court first held that Mr. Lachmund had not stated a claim for fraud against ADMIS because the complaint did not adequately plead agency between Gerlach and ADMIS. The court noted that the complaint pleaded no facts indicating that ADMIS knew of Mr. Lachmund's grain contracts or that it cloaked Gerlach, A/C, or A/C 2000 with actual or apparent authority to act on ADMIS's behalf with respect to such contracts or any futures transactions. The court concluded that the allegation of a guarantee agreement between ADMIS and A/C was insufficient to plead agency, even under the liberal pleading requirements of the federal rules.

The district court next held that Mr. Lachmund did not plead any RICO violations adequately under Federal Rule of Civil Procedure 9(b). Mr. Lachmund's agency allegations were insufficient to plead that ADMIS violated 18 U.S.C. sec. 1962(c) through any agents. Likewise, the court held, his complaint failed to plead any direct violation of sec. 1962(c) by ADMIS with the particularity required by Rule 9(b). The court further found that Mr. Lachmund's complaint did not adequately plead a conspiracy among the defendants in violation of sec. 1962(d) or any violation of sec. 1962(a) by A/C or ADMIS.

Finally, the district court held that Mr. Lachmund did not adequately plead a claim under the CEA because the HTA contracts were cash forward contracts that are exempt from regulation under the CEA. Because the contracts were between a farmer and a grain elevator and contemplated the physical transfer of actual grain, and because the complaint did not contain allegations that the parties' intentions were purely speculative or any other indication that the contracts were "futures contracts" as opposed to cash forward contracts for the exchange of actual grain, the court...