Marchese v. Shearson Hayden Stone, Inc.

• Decision Date: 11 September 1986
• Docket Number: Civ. No. 78-4298-WMB.
• Citation: 644 F. Supp. 1381
• Parties: Dominic MARCHESE, Plaintiff, v. SHEARSON HAYDEN STONE, INC., a corporate entity, Defendant.
• Court: U.S. District Court — Central District of California

644 F. Supp. 1381

Dominic MARCHESE, Plaintiff, v. SHEARSON HAYDEN STONE, INC., a corporate entity, Defendant.

Civ. No. 78-4298-WMB.

United States District Court, C.D. California.

September 11, 1986.

David Daar, Miller & Daar, Los Angeles, Cal., for plaintiff.

Samuel A. Keesal, Jr., Keesal, Young & Logan, Long Beach, Cal., for defendant.

ORDER GRANTING MOTION TO DISMISS

WM. MATTHEW BYRNE, Jr., District Judge.

Plaintiff, Dominic Marchese, filed this action against Shearson Hayden Stone, Inc. (Shearson), a securities broker and futures commission merchant, seeking a declaratory judgment that "interest and increment" on margin funds maintained pursuant to section 4d of the Commodities Exchange Act (CEA), 7 U.S.C. section 6d (1982 & Supp. III 1985), may not be retained by Shearson in excess of its lawful commission. The action is brought on behalf of a class consisting of all persons, who, within the relevant limitations period, gave money, securities, or property to Shearson to margin, guarantee or secure trades or contracts.

Shearson has moved to dismiss the amended complaint on the basis that it fails to state a claim on which relief can be granted. The central issue presented by this motion is whether under section 4d of the CEA and its attendant regulations the interest and increment earned on margin funds is the property of the futures commission merchant. This Court finds that the futures commission merchant is entitled to retain all interest and increment on margin funds, and the motion to dismiss is granted.

I.

Investors enter into contracts of purchase or sale of commodities for future delivery as a means of speculating on the price changes in various commodities. The investors do not ordinarily anticipate taking delivery of the commodity, rather, they seek to enter into "offsetting" contracts prior to the delivery date, liquidate their obligations, and reap a profit should the market price move favorably. H.R.Rep. No. 93-975, 93rd Cong., 2d Sess. 1, 149, reprinted in 1974 U.S.Code Cong. & Ad. News 5843 (House Report) (only 3% of all futures contracts culminate in delivery). Thus an investor who enters into a contract to purchase a specified quantity of a commodity at a date three months hence, can later sell that contract at a profit, if the price of the commodity has increased. If the price of the commodity decreases, the investor can enter into a contract to sell the same quantity of the commodity on the same date, offset the previous obligation, and realize the loss without taking delivery.

Futures contracts must be fungible so that investors can enter into these offsetting transactions. Accordingly, futures contracts for a given commodity are uniform as to quantity, quality, and time and place of delivery. See Merrill Lynch, Pierce, Fenner & Smith v. Curran, 456 U.S. 353, 358, 102 S.Ct. 1825, 1829, 72 L.Ed.2d 182 (1982) (Curran). The only significant non-standardized feature of a commodities contract is the price. See Commodity Fut. Trad. Comm. v. Co Petro Marketing, 680 F.2d 573, 579 (9th Cir. 1982).

Futures trading occurs on exchanges designated as contract markets by the Commodities Futures Trading Commission (CFTC), CEA, 7 U.S.C. section 4a. Generally, an investor makes his futures trades through a Futures Commodities Merchant (FCM), who may be viewed as the commodities counterpart to a securities broker. In addition to the FCM's role in the exchange, each contract market has an affiliated clearing organization which is substituted as the buyer to every seller, and as the seller to every buyer. This substitution occurs at the end of each trading day; thereafter the contracting parties are obligated only to the clearing organization. See Cargill, Inc. v. Hardin, 452 F.2d 1154 (8th Cir.1971), cert. denied, 406 U.S. 932, 92 S.Ct. 1770, 32 L.Ed.2d 135 (1972).

An investor must deposit a specified amount of money with the FCM when he enters into a futures transaction. This deposit, called "initial margin money" or "original margin" insures that the contract will be performed. The FCM, in turn, is required to deposit margin with the clearing organization to secure the investor's futures position.

Contract markets determine the minimum initial margin which must be deposited by the investor, as well as what form the margin may take (cash, Treasury bills or securities). The margin not only varies with each contract market, but with the underlying commodity itself. As the price of the futures contracts fluctuate, the investor may be required to make adjustments to the margin account. If the price moves adversely to the investor's position, his margin will be viewed as declining, and he will be required to deposit additional funds. This "margin call" is necessary to restore the margin account to the initial margin level. On the other hand, if the price moves favorably, the investor may be permitted to withdraw funds from the margin account. See Crabtree Investments v. Merrill Lynch, 577 F.Supp. 1466, 1470 n. 8 (M.D.La.1984), aff'd mem., 738 F.2d 434 (5th Cir.1984).

Although the futures market provides investors with a vehicle for speculation, it also serves a number of economic functions. Agricultural producers can use futures contracts to sell their crops for future delivery, thereby reducing the fluctuation in crop prices from season to season. Cargill, supra at 1157-58. Similarly, the producers can use futures contracts to "hedge" against future decreases in the price of their crops, and food processors can use them to "hedge" against future price increases. Curran, supra 456 U.S. at 358, 102 S.Ct. at 1829. The investors therefore play a vital role in the futures market, by assuming the risk the producers wish to avoid, and by providing the breadth and volume of transactions necessary to allow producers easy access into the futures market. House Report, supra, at 138.

II.

In 1921, Congress, concerned with manipulation and other abuses in futures trading, sought to exercise federal control over the emerging futures market. The Future Trading Act, ch. 86, 42 Stat. 187 (1921) was enacted, which levied a tax on grain futures contracts not traded on an exchange designated as a "contract market". The Secretary of Agriculture was empowered to designate an exchange as a contract market when that market made provision for the prevention of the manipulation of prices, and the dissemination of misleading information.¹ The original act therefore set up a structure where the exchange policed itself — a structure which has persisted despite the legislation's periodic amendment.

In 1922, the Futures Trading Act was declared unconstitutional by the Supreme Court in Hill v. Wallace, 259 U.S. 44, 42 S.Ct. 453, 66 L.Ed. 822 (1922) as an improper use of the taxing power. Congress responded by deleting the tax provision and enacting the Grain Futures Act, ch. 369, 42 Stat. 998 (1922), which prohibited off-exchange futures transactions.² In addition, the new Act provided for misdemeanor penalties for violations of its provisions.³

Prior to 1936, brokers commingled customer monies with their own, used customer monies as part of their own working capital, lent customer deposits to other customers, and used customer monies for their own speculative purposes. 80 Cong.Rec. S7856 (1936). Similarly, banks holding customer funds commingled and used these funds as their own. And, in the event of the bankruptcy of a broker or bank, the customers ranked only as general creditors, and suffered considerable losses. Id. at S6162.

Congress responded by enacting the Commodities Exchange Act, ch. 545, 49 Stat. 1491 (1936), which broadened the scope of federal regulation to include other commodities, and set out several new requirements. Significant among the new requirements was section 4d(2), which mandated, inter alia, that FCMs treat funds and property received by them "to margin, guarantee, or secure" trades or contracts or accruing "as the result of such trades or contracts" as belonging to the customer. Ch. 545, 49 Stat. 1494.⁴ Section 4d(2) further required that customer funds and property be separately accounted for; FCMs were prohibited from commingling customer funds with their own funds, or using customer funds to margin the trades of other customers. Section 4d(2) authorized FCMs to continue investing customer monies, but carefully circumscribed the class of permissible investments.⁵

In 1968, the CEA was amended, once again broadening the scope of the legislation and strengthening the enforcement provisions. The Secretary was authorized to disapprove contract market rules which violate the statute or its regulations, and suspend the contract market if it failed to enforce its rules.⁶ Congress further amended the statutory scheme with the passage of the Commodity Futures Trading Commission Act of 1974, Pub.L. 93-463, 88 Stat. 1389 (1974), and the Futures Trading Act of 1978, Pub.L. 95-405, 92 Stat. 865 (1978), respectively. These amendments created the Commodities Futures Trading Commission to take over the Secretary of Agriculture's responsibilities and discharge new obligations. Like the earlier enactments, the amendments also expanded the statute's coverage and increased penalties for its violation.⁷

Finally, in 1982, Congress reexamined the statutory scheme and enacted the Futures Trading Act of 1982, Pub.L. 97-444, 96 Stat. 2294 (1982). The Act reauthorized the Commodity Futures Trading Commission for another four years. It also settled a bitter jurisdictional dispute between the CFTC and SEC over new financial products such as stock index futures, and various types of options. And, significantly, it expressly provided for a private right of action for violation of its provisions.

III.

Dominic Marchese entered into a series of Commodity Customer Agreements with Shearson during the period when he employed Shearson as his futures commission merchant. One of these agreements contained an arbitration...