# Commodity Futures Trading Commission v. Sterling Trading Group, Inc.

> District Court, S.D. Florida · March 20, 2009 · 605 F. Supp. 2d 1245

URL: https://www.frixlaw.com/law-library/cases/2511506

## Case

- **Full name:** COMMODITY FUTURES TRADING COMMISSION, Plaintiff, v. STERLING TRADING GROUP, INC., Universal FX, Inc., QIX, Inc., STG Global Trading, Inc., Graystone Browne Financial, Inc., Joseph Arsenault, and Andrew Stern, Defendants
- **Court:** District Court, S.D. Florida
- **Decided:** March 20, 2009
- **Citations:** 605 F. Supp. 2d 1245; 2009 U.S. Dist. LEXIS 22710; 2009 WL 737421
- **Precedential status:** Published
- **Opinion:** Opinion by Moore
- **Judges:** K. Michael Moore
- **Cited by:** 4 later opinions in the Frix Law Library

## Citator (automated)

- No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases.
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/2511506

## Opinion text

ORDER ADOPTING REPORTS OF MAGISTRATE JUDGE (dkt #270, 271, 273); DENYING PLAINTIFF’S MOTION FOR PRELIMINARY INJUNCTION (dkt #3); GRANTING IN PART AND DENYING IN PART DEFENDANTS’ MOTION TO DISMISS (dkt #159); GRANTING IN PART AND DENYING IN PART PLAINTIFF’S MOTION FOR SUMMARY JUDGMENT (dkt #202)
K. MICHAEL MOORE, District Judge.
THIS CAUSE came before the Court on the Magistrate Judge’s Report and Recommendation on Plaintiff Commodity Futures Trading Commission’s (“CFTC”) Motion for Preliminary Injunction (dkt # 270) filed on July 23, 2007; Report and Recommendation on Defendants’ Motion to Dismiss (dkt # 271) filed on July 24, 2007; and Report and Recommendation on the CFTC’s Motion for Summary Judgment (dkt #273) filed on July 30, 2007. The CFTC filed its Objections to the Magistrate Judge’s Reports (dkt # 279) on August 22, 2007 and the Defendants filed their Response to the CFTC’s Objections (dkt # 284) on September 25, 2007. The Defendants filed their Objections to the Magistrate Judge’s Reports (dkt # 278) on August 22, 2007, the CFTC filed its Response to the Defendants’ Objections (dkt # 283) on September 24, 2007, and Defendants filed a Reply (dkt # 285) on October 4, 2007.
UPON CONSIDERATION of Magistrate Judge Simonton’s Reports and Recommendations, after a de novo review of the record, and being otherwise fully advised in the premises, the Court enters the following Order.
*1249
I. BACKGROUND
A.
Factual Background
In the interests of brevity, the Court adopts by reference the factual background laid out by the Magistrate Judge in her Report on the CFTC’s Motion for Preliminary Injunction (dkt # 270 at 1270-90) except as objected to by the Parties as noted herein.
B.
Procedural Background
On June 7, 2004, the CFTC filed a four-count Complaint alleging violations of the Commodities Exchange Act (“CEA”), as amended by the Commodities Futures Modernization Act of 2000 (“CFMA”), against Defendants Sterling Trading Group, Inc. (“Sterling”), Universal FX,
Inc. (“UFX”), STG Global Trading, Inc. (“STG”), QIX, Inc. (“QIX”), Graystone Browne Financial, Inc. (“Graystone”), Joseph Arsenault and Andrew Stern (collectively, “Defendants”), (dkt # 1.) On the same day, the CFTC filed a Motion for Preliminary Injunction seeking injunctive relief stemming from Defendants alleged violations of the CEA. (dkt # 3.) The Motion for Preliminary Injunction was referred to Magistrate Judge Simonton. (dkt # 14.) The Motion for Preliminary Injunction was fully briefed, an evidentiary hearing was held, and the Magistrate Judge wrote a Report recommending that the Motion be denied, (dkt # 270.)
On April 15, 2005 the CFTC filed a five-count Amended Complaint against Defendants.
1
(dkt # 151.) The Amended
*1250
Complaint concerns allegedly fraudulent foreign currency (“forex”) transactions involving Defendants. The Amended Complaint divides the allegedly fraudulent and illegal activity into two “phases,” based on the time period of the forex transactions and the Defendants involved. The CFTC alleges that during Phase I of the operations, which occurred between July of 2002 and August of 2003, Sterling, controlled by Arsenault, used misleading radio advertisements; high-pressure, misleading telemarketing sales tactics; false and misleading account-opening documents; and other deceptive practices to fraudulently solicit retail customers to engage in foreign currency futures transactions with UFX, which was controlled by Stern. The Amended Complaint also alleges that these transactions were illegal since UFX was not a proper counterparty to the transactions. (Amended Complaint ¶¶ 20-77.)
The Amended Complaint also alleges that during Phase II of the operations, which occurred between August of 2003 and June 7, 2004, Graystone and STG, under the control of Arsenault, solicited retail customers to enter into foreign currency options transactions with QIX, which was controlled by Stern. The Amended Complaint alleges that Graystone and STG used false and misleading sales solicitation materials, high-pressure and deceptive sales tactics, and failed to provide access to account information regarding these transactions. The Amended Complaint also alleges that these transactions were illegal since QIX was not a proper counter-party to the transactions (Amended Complaint ¶¶ 77-108).
Defendants filed a joint Motion to Dismiss the Amended Complaint on May 13, 2005. (dkt # 159.) The Motion to Dismiss was referred to Magistrate Judge Simon-ton. (dkt # 257.) The Motion to Dismiss was fully briefed, and the Magistrate Judge wrote a Report recommending that the Motion be granted as to Counts I, III, and part of Count IV of the Amended Complaint, and otherwise denied, (dkt #271.) The CFTC filed a Motion for Summary Judgment on January 3, 2006. (dkt # 202.) The Motion for Summary Judgment was referred to Magistrate Judge Simon, (dkt # 257.) The Motion for Summary Judgment was fully briefed, and the Magistrate Judge wrote a Report recommending that summary judgment be granted as to liability on Count V of the Amended Complaint, and otherwise denied. (dkt #273.) Prior to writing her Reports, the Magistrate Judge held five days of evidentiary hearings.
C.
The Magistrate Judge’s Reports and the Parties’ Objections
1. Report on the CFTC’s Motion for Preliminary Injunction
In her Report on the CFTC’s Motion for Preliminary Injunction, the Magistrate Judge began by discussing the CFTC’s jurisdiction under the CEA. The Magistrate Judge found that UFX and QIX are not statutorily exempt as counterparties under the CEA. Accordingly, UFX and QIX are subject to the CFTC’s jurisdiction
*1251
with respect to all provisions of the CEA. The Magistrate Judge also found that the CFTC has the authority to enforce all regulations existing at the time of the CFMA’s enactment, including regulations prohibiting off-exchange transactions and those governing principal/agent and control person liability.
The Magistrate Judge also found that the Seventh Circuit’s opinion in
CFTC v. Zelener,
373 F.3d 861 (7th Cir.2004), provides the proper standard for determining whether the Phase I transactions were futures contracts (over which the CFTC has jurisdiction) or spot transactions (over which the CFTC does not have jurisdiction). The Magistrate Judge found that under
Zelener ,
the key consideration in identifying a futures contract is its fungibility. The Magistrate Judge also noted that the
Zelener
Court had expressly rejected the CFTC’s argument that its interpretation of the term “futures contract” deserves deference under
Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc.,
467
U.S. 837,
104 S.Ct. 2778 , 81 L.Ed.2d 694 (1984). Applying the
Zelener
standard to the Phase I transactions, the Magistrate Judge determined that the Phase I transactions were spot transactions not subject to the CFTC’s jurisdiction. Accordingly, the Magistrate Judge held that Counts I and II of the Complaint, as well as that part of Count III which relates to UFX, cannot support injunctive relief.
Next, the Magistrate Judge rejected the CFTC’s argument that QIX falsely represented that it was a registrant under the Act, and falsely represented, in connection with the handling of orders for foreign currency options, that the options would be executed by or through a member of a registered entity. The Magistrate Judge found that to the extent that QIX made initial misrepresentations, the misrepresentations were promptly corrected. In addition, QIX has ceased doing business, and there is no likelihood that it will resume business. Therefore, to the extent that the CFTC has not abandoned its argument by failing to present it in its post-hearing brief, the Magistrate Judge found injunctive relief is not necessary with respect to this alleged violation.
Finally, the Magistrate Judge ' found that, although 17 C.F.R. § 32.11 , the regulation that prohibits off-exchange transactions, applies to QIX’s transactions, the totality of the circumstances
2
demonstrated that preliminary injunctive relief was not warranted.
2. Report on Defendants’ Motion to Dismiss
In her Report on Defendants’ Motion to Dismiss, the Magistrate Judge began by rejecting the CFTC’s argument that the Defendants’ jurisdictional challenge directly implicates the merits of their claim, and therefore the Court should apply the summary judgment standard in evaluating its jurisdiction. Next, the Magistrate Judge repeated her finding from the Report on the CFTC’s Motion for Preliminary Injunction regarding use of the
Zelener
standard for determining whether the Phase I transactions were futures contracts or spot transactions. As the Magistrate Judge determined that the transactions in Phase I do not fall within the jurisdiction of the CFTC, she recommended that Counts I
*1252
and III of the Complaint, as well as that part of Count IV which relates to UFX, be dismissed. This would result in the dismissal of Defendants Sterling and UFX from this ease, but Defendants Arsenault and Stern would remain subject to other counts alleged in the Complaint.
Next, consistent with her finding in the Report on CFTC’s Motion for Preliminary Injunction, the Magistrate Judge found that UFX and QIX are not exempt counterparties under 7 U.S.C. § 2 (c)(2)(B)(ii) and, as such, Defendants are subject to the provisions of the entire CEA with respect to Phase II transactions. The Magistrate Judge also repeated her finding that the CFTC has the authority to enforce all regulations existing at the time of the CFMA’s enactment, including regulations prohibiting off-exchange transactions and those governing principal/agent and control person liability. Since QIX is not an entity exempted in any respect from the jurisdictional reach of the CFTC, and since all existing statutes and regulations apply to the activities of Defendants with respect to the transactions at issue in Phase II, the Magistrate Judge recommended that the Motion to Dismiss Counts Two, Four and Five be denied.
The Magistrate Judge also rejected Defendants’ argument that restitution is not an available avenue of relief in this case. The Magistrate concluded that the language, legislative history, and purpose of the CEA as well as the equitable powers of federal courts militate in favor of allowing the CFTC to seek restitution.
Finally, the Magistrate Judge recommended that Defendants’ motion to dismiss or for a more definite statement with respect to the control person and prineipal/agent claims be denied. The Magistrate Judge found that the Amended Complaint contained sufficiently coherent and detailed factual allegations, concise statements of facts, and specific allegations against each Defendant.
3. Report on the CFTC’s Motion for Summary Judgment
In her Report on CFTC’s Motion for Summary Judgment, the Magistrate Judge began her legal findings by repeating her recommendation that QIX was not an exempt counterparty under 7 U.S.C. § 2 (c)(2)(B)(ii). The Magistrate Judge also repeated her finding that the CFTC has the authority to enforce all regulations existing at the time of the CFMA’s enactment, including regulations prohibiting off-exchange transactions and those governing principal/agent and control person liability.
The Magistrate Judge went on to recommend that summary judgment should be denied as to Count Two. Count Two alleges that Defendants Graystone, STG, Arsenault, and QIX committed fraud and deceit in the offer and sale of off-exchange foreign currency options. Reviewing Eleventh Circuit cases on the CFTC’s burden of establishing fraud as a matter of law, the Magistrate Judge concluded that the record was insufficient to conclude that the scripts and radio advertisements of Defendants were materially misleading as a matter of law.
Next, the Magistrate Judge recommended that summary judgment be granted as to liability on Count Five. Count Five alleges that Defendants STG, Gray-stone, QIX, Arsenault, and Stern violated 7 U.S.C. § 6c(b) and 17 C.F.R. § 32.11 (a) through the offer and sale of commodity options not conducted or executed on, or subject to the rules of a contract market or a foreign board of trade. The Magistrate Judge found that it was undisputed that STG, Graystone and QIX were soliciting, accepting funds for and offering to enter into foreign currency option transactions that were not traded on either a contract market or foreign board of trade. The
*1253
Magistrate Judge further concluded that Defendants Arsenault and Stern were liable under the CEA’s controlling person statute, 7 U.S.C. § 13 (b), as they had the power and the ability to control the activities of their respective companies with respect to the decision to engage in off-exchange trading of foreign currency options.
Finally, the Magistrate Judge recommended that summary judgment be denied as to Count Four with respect to QIX and Stern. Count Four alleges that Defendants QIX and Stern violated 7 U.S.C. § 6h by falsely representing that QIX was a member of a registered entity and/or that QIX was a registrant under the Act. The Magistrate Judge found that there was considerable dispute regarding the inferences to be drawn from the representations in question.
4. Objections
Defendants present the following objections to the Magistrate Judge’s Reports. First, Defendants argue that the Magistrate Judge erred in finding CFTC jurisdiction over QIX, Stern, and Arsenault. Defendants argue that QIX is exempt from the CFTC’s forex jurisdiction as QIX falls within the “affiliated person” exemption of the CFMA. Defendants further argue that even if QIX were subject to the CFTC’s forex jurisdiction, the CFTC’s jurisdiction does not extend to principal/agent and controlling person claims. Because QIX’s only liability in Count II is premised on a principal/agent claim and Stern and Arsenault’s liability is limited to controlling person claims in Counts IV and V, Defendants argue that these claims should be dismissed. Second, Defendants argue that the Magistrate Judge erred in finding a per se violation of 17 C.F.R. § 32.11 (a) by QIX on the basis of QIX’s supposed failure to qualify for the affiliated person exemption. Defendants argue that the CFMA does not grant the CFTC the authority to use regulations existing prior to the enactment of the CFMA — including § 32.11(a) — as part of its limited forex jurisdiction. Third, Defendants argue that the Magistrate Judge erred in granting summary judgment to the CFTC on its controlling person claims against Stern and Arsenault in Count V because the CFTC was required to show a “lack of good faith” to prove controlling person liability, and the Magistrate Judge acknowledged ample record evidence of Defendants’ good faith. Finally, Defendants argue that the Magistrate Judge erred in finding that the CFTC has jurisdiction to recover restitution under 7 U.S.C. § 13a-1. Defendants argue that § 13a-l does not mention restitution among the specific remedies it provides and the existence of the CEA’s comprehensive enforcement scheme precludes the CFTC’s authority to seek restitution under § 13a-l.
The CFTC presents a number of its own objections to the Magistrate Judge’s Reports. First, the CFTC argues that the Magistrate Judge failed to accord proper
Chevron
deference to the CFTC’s interpretation of the meaning of the term “futures contract” in the CEA. Second, the CFTC argues that the Magistrate Judge improperly relied on the Seventh Circuit’s decision in
Zelener
in holding that the Phase I transactions were not futures contracts subject to the CFTC’s jurisdiction. Third, the CFTC argues that, under either its preferred multi-factor approach or the
Zelener
approach, the Phase I transactions were futures contracts covered by the CEA. Specifically, the CFTC argues that the transactions at issue were fungible and standardized, were not “spot sales for delivery within 48 hours,” and provided for customer offset, contrary to the findings of the Magistrate Judge. Fourth, the CFTC urges the Court to adopt its multi-factor approach to defining a futures contract
*1254
because it provides for more legal certainty regarding the CFTC’s jurisdiction. Fifth, and finally, the CFTC argues that the Magistrate Judge erred in concluding that the jurisdictional question presented in Defendants’ Motion,to Dismiss is distinct from the Defendants’ alleged fraud.
II. ANALYSIS
A.
Regulatory Background
Initially, the only commodities regulated by Congress were certain grain futures transactions under the Grain Futures Act. In 1936, Congress renamed the Grain Futures Act the CEA, and expanded its coverage to include additional agricultural commodities. Until 1974, forex transactions were not covered by the CEA. In 1974, the CEA was greatly expanded to cover,
inter alia,
trading in foreign currency. In addition, Congress created the CFTC, and granted it the power to investigate complaints, hold administrative hearings, order reparations, and seek injunctive relief.
See Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran,
456 U.S. 353, 357-58 , 102 S.Ct. 1825 , 72 L.Ed.2d 182 (1982);
CFTC v. Next Fin. Serv. Unltd.,
Case No. 04-80562: (dkt # 85 at 11) (S.D. Fla. June 7, 2005). Based upon a concern expressed by the Treasury Department, however, coverage of foreign currency transactions was limited by a provision now known as “the Treasury Amendment.” This amendment exempted from CFTC jurisdiction “transactions in foreign currency ... unless such transactions involve the sale thereof for future delivery conducted on a board of trade.”
Next Fin. Sen.,
at 8-9.
The CFTC took the position that the exemption should be narrowly construed and that it was not applicable to options contracts. In
Dunn v. CFTC,
519 U.S. 465, 469 , 117 S.Ct. 913 , 137 L.Ed.2d 93 (1997), the United States Supreme Court squarely rejected this position, holding that the phrase “transactions in foreign currency” included transactions in options to buy or sell foreign currency. The Court, however, did not address the meaning of the phrase “conducted on a board of trade,” and the lower courts were split on the issue of whether this meant that only interbank transactions were exempt, or whether all off-exchange transactions were exempt.
CFTC v. G7 Advisory Serv., LLC,
406 F.Supp.2d 1289, 1294 (S.D.Fla.2005) (Dimitrouleas, J.). The confusion was caused in part by the definition of “board of trade” as “any exchange or association, whether incorporated or unincorporated, of persons who are engaged in the business of buying or selling any commodity.”
Id.
In 2000, Congress enacted the CFMA with the stated purpose of “clarifying the jurisdiction of the [CFTC] over certain retail foreign exchange transactions.” Judge Dimitrouleas explained the nature of this “clarified” jurisdiction in
G7 Advisory Sen.:
The CFMA, as codified in Title 7, United States Code, § 2 (c)(2)(B) grants the CFTC jurisdiction over all off-exchange foreign currency transactions involving noneligible contract participants unless the counterparties to the transactions are an entity enumerated in 7 U.S.C. § 2 (c)(2)(B)(ii). The CFMA’s listing of specified unregulated entities eliminated the need for judicial interpretation of the term “Board of Trade,” which the CFMA redefined as “any organized exchange or other trading facility.” 7 U.S.C. § la(2).
406 F.Supp.2d at 1295
B.
Defendants’Objections
1. Defendants object to the Magistrate Judge’s finding that QIX does not qualify for the “affiliated person” exemption.
*1255
The CFMA grants the CFTC a limited grant of jurisdiction over foreign currency transactions: “[T]he Commission shall have jurisdiction over, an agreement, contract, or transaction in foreign currency that ... is a contract of sale of a commodity for future delivery (or an option on such a contract) ... and is offered to, or entered into with, a person that is not an eligible contract participant....” 7 U.S.C. § 2 (c)(2)(B).
There are several exemptions carved out of this limited grant of jurisdiction. The exemption relevant to this action concerns affiliated persons of registered futures commission merchants (FCMs). Under the terms of this exemption, the CFTC lacks jurisdiction over a transaction if “the counterparty, or the person offering to be the counterparty, of the person [offered to or entered into with] is ... an affiliated person of a futures commission merchant registered under this Act, concerning the financial or securities activities of which the registered person makes and keeps records under ... section 6f(c)(2)(B) of this Act.” 7 U.S.C. § 2 (e)(2)(B)(ii)(III).
Section 6f(e)(2)(B) provides:
The records required under subparagraph (A) shall describe, in the aggregate, each of the futures and other financial activities conducted by, and the customary sources of capital and funding of, those of its affiliated persons whose business activities are reasonably likely to have a material impact on the financial or operational condition of the futures commission merchant, including its adjusted net capital, its liquidity, or its ability to conduct or finance its operations.
7 U.S.C. § 6f(c)(2)(B). “Subparagraph (A)” (§ 6f(c)(2)(A)) provides in turn:
Each registered futures commission merchant shall obtain such information and make and keep such records as the Commission, by rule or regulation, prescribes concerning the registered futures commission merchant’s policies, procedures, or systems for monitoring and controlling financial and operational risks to it resulting from the activities of any of its affiliated persons, other than a natural person.
7 U.S.C. § 6f(c)(2)(A).
The Defendants argue that the analysis of the exemption ends with the language of § 6f(c)(2)(B). That is, the making and keeping of records by a FCM on “the futures and other financial activities conducted by, and the customary sources of capital and funding of’ the affiliated person perfects the exemption under § 2(c)(2)(B)(ii)(III). As QIX Futures kept these financial records on QIX’s operations, under Defendants’ reading of the exemption, QIX is exempt from CFTC jurisdiction.
The Magistrate Judge interpreted the exemption differently. Under her reading of the exemption, affiliated persons are only exempt if the FCM is required to keep records pursuant to § 6f(c)(2)(B). The Magistrate Judge reasoned that when Congress referenced § 6f(c)(2)(B), it did so for a reason, choosing the specific subpart of the CEA’s statutory provision on Risk Assessment for Holding Company Systems that expressly referred to “records required” to be maintained pursuant to the CFTC’s regulations. Per the CFTC’s regulations, only FCMs possessing sufficient assets are required to keep records.
See
17 C.F.R. § 1.15 (c)(1) (“any futures commission merchant which holds funds or property of or for futures custpmers of less than $6,250,000 and has less than $5,000,000 in adjusted net capital as of the futures commission merchant’s fiscal year-end” is not required to keep records). Because it is undisputed that QIX Futures does not meet the minimum capital requirements, it is not required to keep rec
*1256
ords pursuant to 17 C.F.R. § 1.15 (c)(1). Accordingly, under the Magistrate Judge’s interpretation, QIX Future’s affiliated person, QIX, is not subject to the exemption under § 2(c)(2)(B)(ii)(III). The Magistrate Judge found this interpretation of the exemption to be more in keeping with the spirit of the CFMA: “ ‘Any registered FCM could skirt CFTC regulation merely by electing to keep records, thereby confounding the CFMA’s purpose of making clear which off-exchange foreign currency transactions are subject to CFTC regulation.’ ” (dkt # 271 at 1295
(quoting CFTC v. G7 Advisory Serv., LLC,
406 F.Supp.2d 1289, 1297 (S.D.Fla.2005)).)
The Court agrees with the Magistrate Judge’s interpretation of the exemption under § 2(c)(2)(B)(ii)(III), and finds that QIX is not an “affiliated person” as set forth in that provision. The Court finds that Congress gave the CFTC the authority to limit the extent of the “affiliated person” exemption by explicitly tying it to a record-keeping requirement determined by the CFTC’s own regulations. Additionally, Defendants’ interpretation would allow registered FCMs to avoid CFTC regulation at their discretion, “thereby confounding the CFMA’s purpose of making clear which off-exchange foreign currency transactions are subject to CFTC regulation.”
G7 Advisory Serv.,
406 F.Supp.2d at 1297 ;
accord CFTC v. First Int’l Group, Inc.,
06-20979-CIV-JORDAN (S.D.Fla. Jan. 5, 2007) (dkt #34 at 6);
CFTC v. Next Fin. Serv. Unltd.,
04-80562-CIV-RYSKAMP (S.D. Fla. June 7, 2005) (dkt # 85 at 15-16).
2. Defendants object to the Magistrate Judge’s finding that the CFTC has jurisdiction to assert principal/agent claims against QIX and control person claims against Stern and Arsenault and therefore object to the Magistrate’s recommendation that Defendants’ Motion to Dismiss as to Counts Two, parts of Count Four, and Count Five should be denied.
Section 2(c)(2)(C) of the CFMA provides:
Notwithstanding subclauses (II) and (III) of subparagraph (B)(ii), agreements, contracts, or transactions described in subparagraph (B) shall be subject to 7 USCS §§ 6b, 6c(b), 9, 15, and 13b (to the extent that sections 7 USCS §§ 9, 15, and 13b prohibit manipulation of the market price of any commodity, in interstate commerce, or for future delivery on or subject to the rules of any market), 7 USCS §§ 13a-l, 13a-2, 12(a) if they are entered into by a futures commission merchant or an affiliate of a futures commission merchant that is not also an entity described in subparagraph (B)(ii) of this paragraph.
7 U.S.C. § 2 (c)(2)(C). Defendants argue that the CFTC’s forex jurisdiction is limited to those sections of the CEA listed in § 2(c)(2)(C). More specifically, Defendants argue that Congress intentionally omitted the provisions the CFTC relies on to assert its principal/agent and control person claims — 7 U.S.C. §§ 2 (a)(1)(B) and 13c(b) — from the list of provisions of the CEA expressly incorporated by § 2(c)(2)(C). Under Defendants’ argument, because the CFMA did not expressly incorporate these sections, the CFTC lacks jurisdiction to pursue principal/agent and control person claims.
The Magistrate Judge rejected Defendants’ arguments because “[i]t is manifestly clear that by enacting the CFMA, Congress intended the CFTC to assert the entirety of its jurisdiction, and all of its existing regulations, over foreign currency transactions, with respect to all entities except for those specifically excluded under 7 U.S.C. § 2 (c)(2)(B)(ii).” (dkt # 271 at 1258.)
*1257
This Court concurs with the Magistrate Judge. As an initial matter, the CFTC is not seeking to impose liability pursuant to § 2(c)(2)(C). Section 2(c)(2)(C) is invoked only if QIX qualifies as a proper counter-party, which it does not. Accordingly, the foreign currency options transactions entered into by QIX are subject to all provisions of the CEA.
Accord CFTC v. Valko,
06-60001-CIV-DIMITROULEAS (S.D.Fla. Mar. 12, 2007), (dkt # 129 at 8-9). Further, Defendants’ interpretation would render provisions of the CEA redundant or meaningless in contradiction of basic principles of statutory interpretation.
As expressed by Judge Dimitrouleas:
if § 2(c)(2)(C) is interpreted as restricting CFTC jurisdiction over off-exchange foreign currency transactions to only those provisions listed in § 2(c)(2)(C), that section would render superfluous § 2(c)(2)(B) which grants the CFTC jurisdiction to enforce the entire CEA in off-exchange foreign currency transactions unless the counterparty fits one of the enumerated exemptions. Thus, if Defendants’ reading of the statute — as restricting CFTC jurisdiction to the specific sections listed in § 2(c)(2)(C) — were correct, it would leave § 2(c)(2)(B) meaningless. If, however, § 2(c)(2)(C) is interpreted as reserving CFTC jurisdiction over retail foreign currency transactions between a non-eligible contract participant and an FCM or affiliate of an FCM, both sections can be given their full effect.
CFTC v. Valko,
at 9 (internal citations omitted). Accordingly, the Court finds that the CFTC has jurisdiction to assert principal/agent and control person claims under 7 U.S.C. §§ 2 (a)(1)(B) and 13c(b). Therefore, Defendants’ Motion to Dismiss as to Counts Two, Four, and Five is denied.
3. Defendants object to the Magistrate Judge’s finding that Summary Judgment should be granted as to Count Five.
Section 6e(b) of the CEA provides that “no person shall offer to enter into or confirm the execution of, any transaction involving any commodity regulated under this Act which is of the character of, or is commonly known to the trade as, an ‘option,’ contrary to any rule, regulation or order of the Commission prohibiting any such transaction.” 7 U.S.C. § 6c(b). CFTC Regulation 32.11(a), 17 C.F.R. § 32.11 (a), states that it is unlawful for any person to solicit or accept orders for the purchase or sale of any commodity option, except for commodity option transactions conducted or executed on or subject to the rules of a contract market.
Defendants argue that at the time of the enactment of § 32.11 through its most recent amendment in 1988, the regulation never applied to forex transactions. Defendants further argue that nothing in the CFMA gives the CFTC authority to use § 32.11 as part of its new, limited forex jurisdiction. Thus, Defendants contend, there is no basis for the CFTC to enforce § 32.11 against Defendants. Defendants also argue that Congress could have explicitly made old regulations applicable to the CFMA and enforceable under the § 4c(b) as it did in § 2(h). Section 2(h) exempts certain transactions between eligible commercial entities from the CFMA, but makes this exemption “subject to ... the regulations of the Commission pursuant to section 6e(b) of this title proscribing fraud in connection with commodity option transactions to the extent the agreement, contract, or transaction would otherwise be subject to such sections and regulations.” 7 U.S.C. § 2 (h)(4)(B). Finally, Defendants, relying on the testimony of a former National Futures Association employee, argue that § 32.11 has never applied to forex options transactions.
*1258
The Magistrate Judge found that § 32.11 applies to off-exchange foreign currency transactions because Congress took no affirmative act to deprive § 32.11 of its effect with respect to forex transactions. The Magistrate Judge reasoned that holding that the CFTC lacks the authority to enforce § 32.11 would be contrary to the CFMA’s purpose of clarifying, not revoking, the CFTC’s authority to regulate off-exchange foreign currency transactions. “It is manifestly clear that by enacting the CFMA, Congress intended the CFTC to assert the entirety of its jurisdiction, and all of its existing regulations, over foreign currency transactions, with respect to all entities except for those specifically excluded under 7 U.S.C. § 2 (e)(2)(B)(ii).” (dkt # 270 at 1323-24.)
The Court concurs with the finding of the Magistrate Judge. The Defendants’ argument that § 32.11 never applied to forex transactions prior to the enactment of the CFMA is inaccurate. Defendants overlook the Treasury Amendment’s legislative history, as well as judicial interpretations thereof, which indicate that Congress intended to regulate off-exchange foreign currency transactions not involving banks or sophisticated individuals.
See CFTC v. Next Fin. Serv. Unltd.,
04-80562-CIV-RYSKAMP (S.D. Fla. June 7, 2005) (dkt # 85 at 17).
Defendants’ argument regarding §§ 2(h) and 6c(b) is also flawed as it relies on a limited interpretation of § 6c(b) as an enabling statute allowing the CFTC to promulgate new regulations and ignores the language in the provision incorporating existing regulations: “No person shall offer to enter into, enter into or confirm the execution of, any transaction involving any commodity regulated under this chapter ... contrary to any rule, regulation or order of the Commission prohibiting any such transaction.... ” 7 U.S.C. § 6e(b). Section 32.11 was in effect prior to the enactment of the CFMA, which left section § 32.11 unaltered. Whereas Congress took no affirmative act to deprive § 32.11 of effect insofar as it relates to off-exchange foreign currency transactions, § 32.11 governs Defendants’ conduct.
Accord Next Fin. Sens,
at 18. Therefore, as it is undisputed that STG, Graystone, and QIX were soliciting, accepting funds for and offering to enter into foreign currency option transactions that were not traded on either a contract market or foreign board of trade, this Court finds that STG, Graystone, and QIX violated § 32.11.
Defendants further contest, however, that Defendants Arsenault and Stern were not controlling persons with respect to this violation. The control person liability statute of the CEA provides:
Any person who, directly or indirectly, controls any person who has violated any provision of this Act or any of the rules, regulations, or orders issued pursuant to this Act may be held liable for such violation in any action brought by the Commission to the same extent as such controlled person. In such action, the Commission has the burden of proving that the controlling person did not act in good faith or knowingly induced, directly or indirectly, the act or acts constituting the violation.
7 U.S.C. § 13c(b). A controlling person is liable under 13c(b) if he had “ ‘actual or constructive knowledge of the core activities that constitute the violations at issue and allowed them to continue.’ ”
Commodity Futures Trading Comm’n v. Commonwealth Fin. Group,
874 F.Supp. 1345, 1357 (S.D.Fla.1994)
(quoting In re Matter of Spiegel,
[1987-1990 Transfer Binder] Comm. Fut. L. Rep (CCH) P 24, 103 at 34, 767 (CFTC Jan. 12, 1988)).
Defendants argue that the Magistrate Judge improperly granted summary judgment against Stern and Arsenault as to
*1259
Count V, because a finding of good faith necessarily destroys a controlling person claim, (dkt # 278 at 20-21.) Defendants’ argument rests on a misreading of § 13e(b). The statute is disjunctive and clearly states that the CFTC satisfies its burden of proof by demonstrating either that the controlling person did not act in good faith or that the controlling person knowingly induced the acts constituting the violation. Defendants cite to
Donohoe v. Consolidated Operating & Production Corp.,
30 F.3d 907, 912 (7th Cir.1994) to support their proposition that “good faith” is a long-recognized defense to controlling person liability, (dkt # 278 at 20). However,
Donohoe
is distinguishable as it concerns the application of the good faith defense to the federal securities laws. Defendants do not cite any authority supporting the use of a good faith defense to the CEA’s controlling person provision.
Further, Defendants do not contest the Magistrate Judge’s findings that Stern and Arsenault knowingly induced the offer and sale of options in violation of § 4c(b) of the CEA and CFTC Regulation 32.11(a), except to make the conelusory statement that “Andy Stern’s good faith, and total lack of knowledge of any purported violation (which Joe Arsenault is a beneficiary of), is a matter of record.” This argument is soundly contradicted by the evidence. As stated by the Magistrate Judge:
it is clear that both Arsenault and Stern had the power and the ability to control the activities of their respective companies with respect to the decision to engage in off-exchange trading of foreign currency options. Neither Arsenault nor Stern appear to challenge their control in this respect. Arsenault has not disputed his extensive involvement and control over the operations of STG and Graystone, challenging only the fact that he was aware of any fraud or misrepresentations, and contending that he took extensive steps to eliminate such abuses. Stern disputes his control over the day-to-day operations, but does not appear to dispute his ultimate decision-making authority to control the type of business in which QIX engaged,
or that he is
the person who established QIX for the purpose of engaging in off-exchange foreign currency transactions.
(dkt #273 at 1355-56.) Therefore, Arsenault and Stern were controlling persons, and violated § 13c(b). Accordingly, CFTC’s Motion for Summary Judgment as to liability on Count V is granted.
4. Defendants object to the Magistrate Judge’s finding that the CFTC has jurisdiction to seek restitution under 7 U.S.C. § 13a-l.
Title 7, United States Code, Section 13a-l governs the scope of relief that the CFTC may seek in an action brought in federal court. Section 13a-l authorizes the CFTC to seek injunctive relief, compliance orders, and civil penalties. Defendants contend that this relief is not available because the statute does not specifically authorize the CFTC to seek restitution. Defendants argue in support of their position by contrasting § 13a-l with the statute governing available remedies in administrative proceedings convened by the CFTC — 7 U.S.C. §§ 9 and 15 — which expressly authorizes the CFTC to seek restitution. Defendants further argue that the CEA already gives customers comprehensive rights to recover their losses and specific procedures governing those rights that are not found in § 13a-l. Defendants argue that the lack of a statute of limitations for seeking remedies under § 13a-l, as well as the absence of any regulations prescribing standards of proof and procedures for collecting and distributing restitution to customers, also counsels against reading the ability to seek restitution into § 13a-l.
*1260
In
CFTC v. E-Metal Merchants, Inc.,
the Court rejected an analogous argument, holding that restitution is an available remedy.
[District courts are authorized to order restitution on the basis of the language, legislative history, and purpose of the [CEA] as well as pursuant to the equitable powers of federal courts ... First, the language of the [CEA] does not expressly limit the equitable powers of district courts.
See, e.g.,
7 U.S.C. § 13a-l. The U.S. Supreme Court has taught that “[u]nless otherwise provided by statute, all the inherent equitable powers of the District Court are available for the proper and complete exercise of that jurisdiction. And [when] the public interest is involved in a proceeding of [an equitable] nature, those equitable powers assume an even broader and more flexible character.”
Porter v. Warner Holding Co.,
328 U.S. 395, 398 [ 66 S.Ct. 1086 , 90 L.Ed. 1332 ] (1946).... Next, the [CEA] expressly authorizes the issuance of restraining orders that prohibit the dissipation or disposal of assets, funds, or other property.
See
7 U.S.C. § 13a-l. The legislative history of the [CEA] explains that it was the intent of Congress that restraining orders would enable the CFTC to seek restitution for customers.
See
H.R. Rep. 97-565, pt. 1, at 93,
reprinted in
1982 U.S.C.C.A.N. 3871, 3942. Specifically, the House Report explains that Section 13a-l empowers courts to issue ex parte restraining orders and “such power is provided ... to prohibit movement or disposal of funds, assets, and other property which may be subject to lawful claims of customers.”
Id.
(emphasis added). Last, the Court finds that Plaintiff is seeking restitution in equity, that is, it commenced this action in order to restore to [Defendants’] customers particular funds or property in the possession of the Defendants.
See Great-West Life & Annuity Ins. Co. v. Knudson,
534 U.S. 204, 213-18 [ 122 S.Ct. 708 , 151 L.Ed.2d 635 ] (2002). Thus, its equitable powers having been invoked, the Court finds that it may exercise the full range of those powers.... Consequently, the Court concludes that the CEA authorizes the CFTC to seek and this Court to order both disgorgement and restitution.
No. 05-21571-CIV-LENARD (dkt # 60 at 17-18) (S.D.Fla. Jan. 6, 2006)(footnotes omitted). The Court’s reasoning in
E-Metal
remains sound. Accordingly, the Court finds that the CFTC has the authority to seek restitution under 7 U.S.C. § 13a-l. However, restitution must be limited to the amount of Defendants’ unjust enrichment, and therefore may not be measured by customer losses.
Commodity Futures Trading Comm’n v. Wilshire Inv. Mgmt. Corp.,
531 F.3d 1339, 1345 (11 th Cir.2008).
C.
Plaintiff’s Objections
1. Plaintiff objects to the Magistrate Judge’s finding that the CFTC does not have jurisdiction over the Phase I transactions and that Defendants’ Motion to Dismiss as to Counts I, II, and the part of Count IV pertaining to UFX should be granted.
a.
Zelener
is the appropriate standard for determining whether a forex transaction is a “futures contract”
Under the CEA, the CFTC may exercise its jurisdiction over futures contracts, or “transactions involving contracts of sale of a commodity for future delivery.” 7 U.S.C. § 2 (a)(1)(A). There are two competing methodologies for determining whether a forex transaction is a “futures contract” such that the CFTC has jurisdiction over the transaction. On the one hand is the multi-factor, or “totality of the
*1261
circumstances,” approach set forth in
CFTC v. Co Petro Mktg. Group, Inc.,
680 F.2d 573, 577-81 (9th Cir.1982). This is the approach advocated by the CFTC. A different approach is set forth in
CFTC v. Zelener,
373 F.3d 861 (7th Cir.2004). Under
Zelener ,
a forex transaction is a futures contract if it is a “fungible promise to buy or sell a particular commodity at a fixed date in the future.”
Id.
at 864 . This is the approach advocated by Defendants.
In
Co Petro,
the Ninth Circuit determined whether contracts for the future purchase of petroleum products offered by Co Petro were futures contracts subject to the CFTC’s jurisdiction. The court highlighted three principal features of the contracts in finding that they were not futures contracts: (1) most of Co Petro’s customers were “speculators from the general public;” (2) the commodity underlying the transactions had no inherent value to most of Co Petro’s customers; and (3) Co Petro’s customers “had neither the intention of taking delivery nor the capacity to do so.” 680 F.2d at 578 . The court in
CFTC v. Midland Rare Coin Exchange, Inc.,
71 F.Supp.2d 1257, 1262 (S.D.Fla.1999) listed a similar set of factors as useful in distinguishing futures contracts from other contracts (in this case cash forward transactions). These factors include:
(1) whether the seller of the contracts entered into these contracts only with producers and not with speculators from the general public; (2) whether the buyers and sellers had the ability to take or make delivery on the contracts; (3) whether the seller relied on actual delivery of the commodity to carry out its business; (4) whether the contracts were clearly tools to accomplish the actual delivery of the commodity in exchange for money; (5) whether delivery and payment routinely occurred between the parties in past dealings; • and (6) whether the seller received cash payment on the contracts only upon delivery of the actual commodity.
As noted in
CFTC v. Madison Forex Int’l, LLC,
“at their core, these factors ultimately focus on whether ‘the parties contemplated physical delivery’ of the commodity.” 2006 U.S. Dist. LEXIS 96294 , *19 (S.D.Fla. July 20, 2006).
In
Zelener ,
the Seventh Circuit advanced a different method for determining whether a forex transaction is a futures contract. The transactions at issue in
Zelener
are very similar to the transactions in the instant case:
Two corporations doing business as “British Capital Group” or BCG solicited customers’ orders for foreign currency.... Each customer opened an account with BCG and another with AlaronFX; the documents made it clear that AlaronFX would be the source of all currency bought or sold through BCG in this program, and that AlaronFX would act as a principal. A customer could purchase (go long) or sell (short) any currency; for simplicity we limit our illustrations to long positions. The customer specified the desired quantity, with a minimum order size of $5,000; the contract called for settlement within 48 hours. It is agreed, however, that few of BCG’s customers paid in full within that time, and that none took delivery. AlaronFX could have reversed the transactions and charged (or credited) customers with the difference in price across those two days. Instead, however, AlaronFX rolled the transactions forward two days at a time-as the AlaronFX contract permits, and as BCG told the customers would occur. Successive extensions meant that a customer had an open position in foreign currency. If the dollar appreciated relative to that currency, the customer could close the position and reap the profit in one of two ways: take delivery of the currency
*1262
(AlaronFX promised to make a wire transfer on demand), or sell an equal amount of currency back to AlaronFX. If, however, the dollar fell relative to the other currency, then the client suffered a loss when the position was closed by selling currency back to AlaronFX.
373 F.3d at 863 .
The district court dismissed the action for lack of CFTC subject matter jurisdiction, finding that BCG’s customers were speculating in spot contracts by rolling over their positions and entering into offsetting trades.
CFTC v. Zelener,
2003 WL 22284295 at *4-5, 2003 U.S. Dist. LEXIS 17660 at *14 (N.D.Ill. Oct. 3, 2003). The CFTC appealed, arguing that, under the multi-factor “totality of the circumstances” analysis, the transactions were futures contracts as the currency was sold for speculative purposes to individuals for whom foreign currency had no inherent value and there was no contemplation of physical delivery of the foreign currency.
The Seventh Circuit affirmed the district court’s dismissal and, in the process, rejected the “totality of the circumstances” test. The Court held that the determination must be based on an analysis of the contract, rather than the intention of the parties or whether the contracts ultimately led to delivery:
In organized futures markets, people buy and sell contracts, not commodities. Terms are standardized, and each party’s obligation runs to an intermediary, the clearing corporation. Clearing houses eliminate counterparty credit risk. Standard terms and an absence of counterparty-specific risk make the contracts fungible, which in turn makes it possible to close a position by buying an offsetting contract. All contracts that expire in a given month are identical; each calls for delivery of the same commodity in the same place at the same time. Forward and spot contracts, by contrast, call for sale of the commodity; no one deals “in the contract:” it is not possible to close a position by buying a traded offset, because promises are not fungible; delivery is idiosyncratic rather than centralized.
Co Petro,
the case that invented the multi-factor approach, dealt with a fungible contract,
see
680 F.2d at 579-81 , and trading did occur “in the contract.” That -should have been enough to resolve the case.
It is essential to know beforehand whether a contract is a futures or a forward. The answer determines who, if anyone, may enter into such a contract, and where trading may occur. Contracts allocate price risk, and they fail in that office if it can’t be known until years after the fact whether a given contract was lawful. Nothing is worse than an approach that asks what the parties “intended” or that scrutinizes the percentage of contracts that led to delivery ex post.... But reading “contract of sale of a commodity for future delivery” with an emphasis on “contract,” and “sale of any cash commodity for deferred shipment or delivery” with an emphasis on “sale” nicely separates the domains of futures from other transactions.
Id.
at 865-66. Thus, the Seventh Circuit concluded that the language of the account opening documents
3
— -nearly identical to
*1263
the language in the documents for the transactions in the instant case — did not provide for the automatic right to offset and thus were non-fungible spot sales not subject to the jurisdiction of the CFTC.
Id.
at 869.
The Magistrate Judge, following the reasoning and the holding of
Zelener,
concluded that the Phase I transactions at issue in this case were also non-fungible spot transactions not subject to the jurisdiction of the CFTC. This Court agrees. In its Objections, the CFTC argues that the Magistrate Judge incorrectly applied the
Zelener
approach “by both ignoring or failing to give appropriate weight to contract language, and additionally by relying extensively on the testimony from defendant Andrew Stern to support the Magistrate Court’s conclusion that the UFX and Sterling transactions were not futures contracts.” (dkt #279 at 22.) The CFTC argues throughout its objections that Stern’s testimony constitutes impermissible post hoc evidence under
Zelener,
as it is outside the terms of the contracts and account statements. The CFTC further objects to the Reports on the grounds that the Magistrate Judge improperly suggests that, under
Zelener,
both fungibility and contractual right to offset are necessary to find that a transaction constitutes a futures contract. The CFTC also objects to the Magistrate Judge’s factual findings: specifically, that the contracts were unique in amount of currency and timing, that the transactions were spot sales for delivery within 48 hours, and that the terms and conditions of the UFX’s contracts did not provide the right for customer offset.
4
This Court finds the CFTC’s Objections to be without merit. There is no support for the CFTC’s argument that the
Zelener
standard forbids an examination of facts outside of the contractual obligations. As
*1264
the Defendants note in their Reply to the CFTC’s Objections, the Seventh Circuit in
Zelener
explicitly relied on post hoc evidence beyond the face of the transaction documents in making its findings.
See Zelener,
373 F.3d at 864 (finding that few of BCG’s customers paid in full during two-day period or took delivery and that AlaronFX rolled the transactions forward two days at a time). Additionally, there is no support for the CFTC’s objection that the Magistrate Judge improperly suggested that a finding of fungibility and the contractual right to offset are both required in order for a transaction to be a futures contract. The CFTC does not cite to any portion of the Reports where the Magistrate suggested that both findings were necessary for a transaction to be a futures contract. Additionally, the Magistrate found that the transactions were both non-fungible and did not include a contractual right to offset. Thus, it is unclear on what grounds the CFTC is formulating its objection.
The CFTC’s factual objections as to the Phase I transactions are also unpersuasive. The Magistrate Judge found that the Phase I 'transactions were spot transactions outside the jurisdiction of the CFTC. In support of this finding, the Magistrate Judge relied on the following facts: (1) the account documents, like those in
Zelener,
clearly advised the customers that the transactions were spot transactions and there was no absolute right to offset; (2) like the transactions in
Zelener,
the Phase I transactions were, in form, spot sales for delivery within 48 hours; and (3) the contracts were unique in the amount of currency and in timing.
The factual findings of the Magistrate Judge are well-supported by the Record. A plain reading of the account documents indicates that the right to offset rested with UFX and not the customer. The Phase I transaction account documents state that if the client fails to give timely instructions about the disposition of the positions, then “UFX is authorized, at UFX’s sole discretion, to deliver, rollover or offset all or any portion of the Currency positions in the OTCFX account(s) for Trader’s Account(s) and at Trader’s risk:
(See
dkt # 271 at 1311-12.) In
Zelener,
the Seventh Circuit held that nearly identical contract language did not give the customer an absolute right to offset. See 373 F.3d at 868 . Additional language in the Phase I transaction documents reinforces the Magistrate Judge’s finding that the customer did not have an absolute right to offset its transactions: “UFX will attempt to execute all orders, which it may, in its sole discretion, choose to accept in accordance with the oral or written, or computer instructions of Trader’s. UFX reserves the right to refuse to accept any order.” (Id) The CFTC attempts to argue that language in the account documents referencing “round turn lots” implies a promise by UFX to offset transactions. However, the contract language recited above is clear-the right to offset rests with UFX, not the customer. This Court will not read an ambiguity into the contract language that does not exist. Similarly unavailing is the CFTC’s argument regarding language in the contract referring to the customer’s right to “speculate and/or purchase and/or sell cash or spot foreign currency.” The CFTC claims that the only reasonable interpretation of this language is that UFX is promising the customer a right to offset. Again, in light of the clear contract language reserving the right to offset in UFX, the CFTC’s attempt to read in an ambiguity is unreasonable.
The evidence also supports the Magistrate Judge’s finding that the Phase I transactions were, in form, spot sales for delivery within 48 hours. Defendant Stern testified that UFX used the industry custom of 48 hours as the time between the
*1265
opening of the transaction and the settlement date. The CFTC objects to the Magistrate Judge’s finding by pointing to evidence that customer positions were often left open for several weeks. However, in
Zelener,
“the contract called for settlement within 48 hours” even though “few of BCG’s customers paid in full within that time, and ... none took delivery.” 373 F.3d at 863 . Moreover, the key consideration in determining whether the transactions were futures contracts is their fungibility. As the Seventh Circuit in
Zelener
held, “Rollover, and the magnification of gain or loss over a longer period, does not turn sales into futures contracts ...”
Id.
at 868.
Finally, this Court concurs with the Magistrate Judge’s finding that the Phase I transactions were unique in the amount of currency and in timing. Although UFX’s trading platform only permitted foreign currency transactions in hundred thousand dollar increments, if orders were placed by telephone, the orders could be for any amount of currency. Additionally, although Sterling traded for its customers in hundred thousand dollar increments, other introducing brokers chose different amounts. The CFTC argues that the transactions introduced by Sterling were all for $100,000. However, other brokers besides Sterling introduced trades to UFX. Accordingly, the amount of currency traded was not standardized inasmuch as the tradable amount was not fixed, not governed by any binding rule of standardization, and ultimately a matter within UFX’s discretion. However, even if trading increments were standardized, this Court would still find that the trades at issue were not futures trades because of the other factors militating in favor of such a finding, primarily the absence of an obligation by UFX to accept an offsetting trade.
Regarding timing, because currency could be purchased 365 days a year and the settlement date was set for 48 hours after purchase, settlement dates varied from transaction to transaction depending on the day and hour of purchase. This differs from futures contracts where “[a]ll contracts that expire in a given month are identical; each calls for delivery of the same commodity in the same place at the same time.” Id. at 866. Thus, both the amount of currency and the timing of the Phase I transactions were idiosyncratic — ■ i.e., non-fungible — and therefore consistent with the nature of spot transactions.
All of these findings, individually and collectively, support the conclusion that the Phase I transactions were spot sales, not futures contracts. Accordingly, Counts I and III of the Complaint, as well as that part of Count IV which relates to UFX, are dismissed. This results in the dismissal of Defendants Sterling and UFX from this case.
b. The CFTC’s interpretation of “futures contract” is not entitled to
Chevron
deference.
The CFTC also objects to the Magistrate Judge’s Reports because the Magistrate Judge failed to accord its interpretation of the term “futures contract” proper deference as required by
Chevron U.S.A. Inc. v. NRDC,
467 U.S. 837 , 104 S.Ct. 2778 , 81 L.Ed.2d 694 (1984). Under the CFTC’s interpretation, a “totality of the circumstances” standard — and not the
Zelener
“fungibility” standard — is the proper method for determining whether a transaction is a futures contract.
“When an agency interprets a statute that the agency is responsible for administering, courts must give the agency’s interpretation due deference if (1) Congress has delegated interpretive authority to the agency, (2) the statute is silent or ambiguous with respect to the
*1266
issue at hand, and (3) the agency’s interpretation of the statute is reasonable.”
Sierra Club, Inc. v. Leavitt,
488 F.3d 904, 911-12 (11th Cir.2007)
(citing Chevron U.S.A. Inc. v. NRDC,
467 U.S. 837 , 104 S.Ct. 2778 , 81 L.Ed.2d 694 (1984) and
United States v. Mead Corp.,
533 U.S. 218 , 121 S.Ct. 2164 , 150 L.Ed.2d 292 (2001)). Further,
“Chevron
deference is confined to those instances in which the agency renders its interpretation in the course of a rulemaking proceeding or adjudication.”
TVA v. Whitman,
336 F.3d 1236, 1250 (11th Cir.2003). However, even if an agency’s interpretation of its own statute is advanced in the course of litigation rather than through a rulemaking or agency adjudication, courts will still pay some deference to the agency’s interpretation.
Id.
The Magistrate Judge did not expressly hold that the CFTC’s interpretation of “futures contract” was not entitled to
Chevron
deference.
5
However, in accepting the Seventh Circuit’s approach to defining futures contracts in
CFTC v. Zelener,
373 F.3d 861 (7th Cir.2004), the Magistrate Judge noted that the
Zelener
court found “that the CFTC’s position was not entitled to deference under
Chevron ...
since Congress had not delegated this determination to the CFTC.” (dkt # 270 at 1300.)
This Court finds that, consistent with the Magistrate Judge’s Reports, the CFTC’s interpretation is not entitled to
Chevron
deference. The Court agrees with the Seventh Circuit that Congress has not delegated the CFTC the authority to define “futures contract.”
See Zelener,
373 F.3d at 867 ;
see also CFTC v. Erskine,
512 F.3d 309, 314 (6th Cir.2008). Additionally, this Court agrees with the Sixth Circuit in
Erskine
that, because the CFTC has never defined “futures contract” in a rule-making or adjudication, its interpretation lacks the “administrative formality” entitled to
Chevron
deference.
Id.
In
Zelener,
Judge Easterbrook found that Congress had not delegated authority to the CFTC to define a “futures contract”:
[T]he central point is that deference depends on delegation.
See United States v. Mead Corp.,
533 U.S. 218 , 121 S.Ct. 2164 , 150 L.Ed.2d 292 (2001). When Congress has told an agency to resolve a problem, then courts must accept the answer. When, however, the problem is to be resolved by the courts in litigation — which is how this comes before us — the agency does not receive deference.
Adams Fruit Co. v. Barrett,
494 U.S. 638, 649-50 , 110 S.Ct. 1384 , 108 L.Ed.2d 585 (1990). Courts must heed the agency’s reasoning and give it the benefit of the doubt. But the CFTC has avoided rather than addressed the central issue: is trading “in the contract” a defining characteristic? The agency has assumed a negative answer without explanation. In
Nagel [v. ADM Investor Services, Inc.,
217 F.3d 436 (7th Cir.2000) ],
Chicago Mercantile Exchange [v. SEC,
883 F.2d 537 (7th Cir.1989)], and other decisions, this circuit addressed the subject without extending
Chevron
deference to the Commission; we adhere to that position today.
373 F.3d at 867 . This Court agrees with Judge Easterbrook that Congress has not delegated authority to the CFTC to interpret the term “futures contract.” The Supreme Court has instructed that delegation requires “specific interpretive authority,” which may be express or implied, “to implement a particular provision or fill
*1267
a particular gap.”
Mead,
533 U.S. at 229 , 121 S.Ct. 2164 . The CFTC points to no “particular provision” under the Modernization Act or any other delegated authority to define “futures contracts” with respect to forex.
Moreover, even if the CFTC has such authority, this Court also finds that the CFTC’s interpretation is not entitled to
Chevron
deference. The CFTC has not exercised such authority in the course of a rulemaking proceeding or adjudication in a manner that supports
Chevron
deference as to the use of a multi-factor “totality of the circumstances” test under the circumstances at issue.
Accord, Erskine,
512 F.3d at 314 (the CFTC “has merely asserted its preferred definition during the course of litigation (and in a proposal to Congress for new legislation). This approach does not result in a definition entitled to
Chevron
deference.”). The CFTC argues that for twenty-five years, it has exercised its APA rule-making authority to develop its interpretation of futures contracts. The Court disagrees. The “hybrid” and “swap” rules the CFTC purports to rely on predate the CFMA by over a decade and have nothing to do with forex or the CFMA, and establish no formal methodology for defining futures. The ALJ appeals cited by the CFTC are also not entitled to
Chevron
deference. As stated by Defendants in their Reply to the CFTC’s Objections, “[t]hese appeals, dating from the 1970’s and 1980’s, precede by decades the Modernization Act and the
Zelener
Court’s analysis. Far from articulating the formal adoption of an approach to determining futures contracts in the context at issue, these ALJ opinions are fact-specific reviews relating, like
Mead ,
to ‘transactions of the moment.’ ” (dkt # 284 at 13.) Therefore, this Court finds that the CFTC has not defined “futures contract” in a rule-making or adjudication context sufficiently specific to entitle the CFTC to
Chevron
deference as to the multi-factor “totality of the circumstances” test that the CFTC advocates under the present circumstances.
2. Plaintiff objects to the Magistrate Judge’s finding that Defendants’ challenge to the CFTC’s jurisdiction over the Phase I transactions does not directly implicate the merits of their claim.
In her Report on Defendants’ Motion to Dismiss, the Magistrate Judge rejected the CFTC’s argument that the jurisdictional challenge directly implicates the merits of their claim, and therefore this Court must apply the summary judgment standard in evaluating its jurisdiction, (dkt # 271 at 1310.) The CFTC argues that the jurisdictional issue in this case and the issue of whether the Defendants engaged in fraud are inextricably intertwined; i.e., “both the Commission’s jurisdiction, and the merits of the claims in the Amended Complaint, necessarily involve the question of the proper definitional standard to determine whether the Universal FX transactions are futures contracts.” (dkt #279 at 1.)
This Court agrees with the finding of the Magistrate Judge. As noted by the Magistrate Judge, whether the CFTC has jurisdiction over the Phase I transactions is not at all affected by whether Defendants committed the fraudulent practices alleged in the Amended Complaint. A number of courts in this district have made the same finding.
See CFTC v. Madison Forex Int'l.,
2006 U.S. Dist. LEXIS 96294 , *6 n. 1 (S.D.Fla. July 19, 2006);
CFTC v. Next Fin. Serv., Unltd.,
04-80562-CIV-RYSKAMP, (dkt # 85 at 9-10) (S.D. Fla. June 7, 2005).
III. CONCLUSION
Accordingly, it is hereby
*1268
ORDERED AND ADJUDGED that Plaintiffs Motion for Preliminary Injunction (dkt # 3) is DENIED. It is further
ORDERED AND ADJUDGED that Defendants’ Motion to Dismiss (dkt # 159) is GRANTED IN PART AND DENIED IN PART. The Motion is GRANTED with respect to Counts 1, III, and the portion of Count IV involving UFX, and DENIED in all other respects. It is further ORDERED AND ADJUDGED that Plaintiffs Motion for Summary Judgment is GRANTED IN PART AND DENIED IN PART. The Motion is GRANTED as to Count V, and DENIED as to Count II and the portion of Count IV involving QIX and Stern. It is further
ORDERED AND ADJUDGED that the Report and Recommendation on Plaintiffs Motion for Preliminary Injunction (dkt #270), the Report and Recommendation on Defendants’ Motion to Dismiss (dkt # 271), and the Report and Recommendation on Plaintiffs Motion for Summary Judgment (dkt # 273) are ADOPTED consistent with the terms of this Order.
REPORT AND RECOMMENDATION
ANDREA M. SIMONTON, United States Magistrate Judge.
Presently pending before the Court is Plaintiffs Motion for a Preliminary Injunction (DE # 3). This motion is referred to the undersigned Magistrate Judge to take all necessary and proper action as required by law (DE # 14). The motion is fully briefed, and an evidentiary hearing was held. For the reasons stated below, it is respectfully recommended that the Motion be denied.
Transcripts of the evidentiary hearing have been filed as follows: September 30, 2004 (DE #107); October 1, 2004 (DE # 101); November 17, 2004 (DE # 109); November 18, 2004 (DE # 111); December 16, 2004 (DE # 128).
The following documents have been filed by the parties in connection with this motion:
DE # 4: CFTC’s Memorandum in Support of its Motion for Preliminary Injunction
1
DE # 30: CFTC’s List of Witnesses, Affidavits, and Exhibits
DE #48: Response of Defendants Universal, QIX, and Andrew Stern
DE #49: Defendants’ Joint List of Witnesses, Affidavits and Exhibits
2
DE # 50: Response of Defendants Sterling Trading Group, Inc., STG Global Trading, Inc., Graystone Browne Financial, Inc. and Joseph Arsenault
DE # 59: CFTC’s Notice of Filing Supplemental Declaration of Kyong J. Koh
DE #60: CFTC’s Reply to Defendants’ Opposition
DE #61: CFTC’s Rebuttal List of Affidavits and Exhibits
3
DE # 62: CFTC’s Notice of Filing Attachments and Exhibits to Plaintiffs Rebuttal List
DE # 65: Defendants’ (Stern, Universal FX and QIX) Notice of Filing Supplemental Exhibits
*1269
DE # 72: Joint Statement of Stipulated Facts
DE # 74: CFTC’s Proposed Findings of Fact and Conclusions of Law
DE # 76: Defendants’ (Sterling Trading, STG Global, Graystone Browne, Arsenault) Proposed Findings of Fact and Conclusions of Law
DE # 77: Defendants’ (Stern, Universal and QIX) Proposed Findings of Fact and Conclusions of Law
DE # 78: Defendant Stern’s Supplemental Memorandum in Opposition to Motion for Preliminary Injunction
DE #95: CFTC’s Notice of Filing Exhibit A to Declaration of Robert Firebaugh
DE #97: CFTC’s Notice of Filing Transcript of Broker Solicitation Tape (included as Exhibit 8 to DE # 30)
DE # 112: Defendants’ Notice of Filing List of Exhibits
DE # 132: CFTC’s Notice of Filing transcripts of Sterling radio advertisements previously filed in electronic form in DE # 4, Ex. 2, Attachment Z
DE # 134: CFTC Post-Hearing Brief
DE # 136: CFTC’s Proposed Findings of Fact and Conclusions of Law
DE # 137: CFTC’s Reply to Defendant Stern’s Supplemental Memorandum in Opposition to Motion for Preliminary Injunction
DE # 139: Defendants’ Notice of Filing Additional Authority
(CFTC v. Next Financial Services, et al.,
04-80562-CIV-KLR, 2005 WL 3724788 (S.D.Fla. Jan. 27, 2005)).
DE # 144: Defendants’ Joint Post-Hearing Brief
DE # 145: Defendants’ (Stern, Universal, and QIX) Post Hearing Proposed Findings of Fact and Conclusions of Law
DE # 146: Defendants’ (Sterling Trading Group, STG Global Trading, Graystone Browne, and Arsenault) Post-Hearing Proposed Findings of Fact and Conclusions of Law
DE # 147: Defendants’ (Sterling Trading Group, STG Global Trading, Graystone Browne, and Arsenault) Notice of Filing Compliance Transcripts
DE # 149: Defendants’ (Stern, Universal and QIX) Notice of Filing Declaration of Ronald B. Hobson
DE # 155: CFTC’s Reply to Defendants’ Joint Post-Hearing Brief and Proposed Findings and Conclusions of Law, and Notice of Errata (DE # 156)
DE # 168: Defendants’ Notice of Filing Supplemental Authority in Further Opposition to Plaintiffs Motion for Preliminary Injunction (re: legislative proposals)
DE # 171: CFTC’s Notice of Filing Supplemental Authority and of Order Vacating Authority Cited by Defendants (re:
CFTC v. Next Financial Services Unltd.,
Case No. 04-80562 (S.D. Fla. June 7, 2005))
DE # 173: CFTC’s Motion to Strike Notice of Filing Supplemental Authority re: legislative proposals (deemed a response to the supplemental authority)
DE # 175: Defendants’ Response to Motion to Strike
DE # 176: CFTC’s Notice of Filing Supplemental Authority re: asset freeze
CFTC v. United Investors Group,
Case. No. 05-80002-CIV-Hurley, 2005 WL 3747596 (S.D.Fla. June 9, 2005)
DE # 177: CFTC’s Reply in Support of Motion to Strike
DE # 179: CFTC’s Notice of Filing Supplemental Authority
(CFTC v. National Investment Consultants,
Case No. C05-02641-JSW, 2005 WL 2072105 (N.D.Cal. Aug. 26, 2005))
DE # 198: CFTC’s Notice of Filing Supplemental Authority Relating to Plaintiffs Motion for Preliminary In
*1270
junction
CFTC v. G7 Advisory Services, LLC,
406 F.Supp.2d 1289 (S.D.Fla.2005)
DE # 200: Defendants’ Notice of Filing Supplemental Authority in Further Support
(CFTC v. American Derivatives Corp.,
Case. No. 05-2492-STORY, 2005 WL 3149585 (N.D.Ga. Nov. 23, 2005))
DE # 223: Defendants’ Notice of Filing Supplemental Authority (article entitled, “The Retail FX Conundrum” by Philip McBride Johnson)
DE # 234: CFTC’s Motion to Strike Supplemental Authority contained in DE #223 (which is deemed a response to the supplemental authority)
DE #235: Notice of Filing Supplemental Authority re: restitution issue
(CFTC v. Next Financial Services,
Case. No. 04-80562-CIV-Ryskamp (S.D.Fla. Mar. 17, 2006))
DE # 241: Defendants’ Response in Opposition to Motion to Strike
DE #243: CFTC’s Reply to Response in Opposition to Motion to Strike
DE # 244: Defendants’ Notice of Filing Additional Supplemental Authority
CFTC v. Erskine,
Case No. 04-CV-0016, 2006 WL 1050677 (N.D.Ohio Apr. 19, 2006)
DE # 250: Defendants’ Notice of Filing Additional Supplemental Authority
CFTC v. Madison Forex, Int’l,
Case No. 05-61672-CIV-Altonaga (S.D.Fla. July 19, 2006).
DE # 263: Plaintiffs Notice of Filing of Supplemental Authority
CFTC v. First Int’l Group, Inc.,
Case No. 06-20979-CIV-JORDAN (S.D.Fla. Jan. 5, 2007).
I.
BACKGROUND
The Commodity Futures Trading Commission (“CFTC”) initially filed a four-count Complaint alleging violations of the Commodities Exchange Act (“the Act”), as amended by the Commodities Futures Modernization Act of 2000 (“the Modernization Act”), against Defendants Sterling Trading Group, Inc. (“Sterling”), Universal FX, Inc. (“UFX”), STG Global Trading, Inc. (“STG”), QIX, Inc., Graystone Browne Financial, Inc. (“Graystone”), Joseph Arsenault and Andrew Stern. In the pending motions, the CFTC seeks a preliminary injunction which (1) prohibits future violations of the Commodity Exchange Act, as amended by the Commodity Futures Modernization Act of 2000; (2) continues the temporary restraining order which prohibited the destruction or alteration of books, records and documents of the Defendants;
4
and (3) which freezes the assets of the Defendants, requires an accounting of such assets, requires repatriation to the United States of foreign-held assets, and requires Defendants to sign consents to the release of financial records and to waive the protections of foreign bank secrecy laws.
More specifically, the Complaint alleges in Count One that Defendants Sterling, Universal, Arsenault, and Stern committed fraud and deceit in the offer and sale of foreign exchange futures contracts, in violation of 7 U.S.C. § 6b(a)(i) and (iii) (Section 4b(a)(2)(i) and (iii) of the Act) and 17 C.F.R. § 1.1 (b)(1) and (3).
*1271
In Count Two, the Complaint alleges that Defendants Sterling, Universal, Arsenault and Stern violated 7 U.S.C. § 6 (a) (Section 4(a) of the Act) through the offer and sale of commodity futures contracts which were not conducted on a board of trade designated as a contract market.
In Count Three, the Complaint alleges that Defendants Universal, QIX and Stern violated 7 U.S.C. § 6h (Section 4h of the Act) by falsely representing that Universal and QIX were a member of a registered entity or that Universal and QIX were registrants under the Act.
In Count Four, the Complaint alleges that Defendants STG, Graystone, QIX, Arsenault, and Stern violated 7 U.S.C. § 6e(b) (Section 4c(b) of the Act) and 17 C.F.R. § 32.11 (a) through the offer and sale of commodity options not conducted or executed on, or subject to the rules of a contract market or a foreign board of trade.
The Complaint concerns transactions that occurred during two different phases of operations involving overlapping defendants. The CFTC alleges that during Phase I of the operations, which occurred between July 2002 and August 2003, Sterling, acting under the control of Arsenault as an agent and introducing entity for Universal, used misleading radio advertisements and high-pressured, misleading telemarketing sales tactics to fraudulently solicit retail customers to engage in illegal foreign currency futures transactions with Universal, which was controlled by Stern (Complaint ¶¶ 20-76).
The Complaint alleges that during Phase II of the operations, which occurred between August 2003 and June 7, 2004, Graystone and STG, under the control of Arsenault, solicited retail customers to enter into foreign currency options transactions with QIX, which was controlled by Stern. The Complaint alleges that these transactions were illegal since QIX was not a proper counterparty to the transactions (Complaint ¶¶ 77-91).
5
Defendants argue that the transactions which occurred during Phase I were “spot transactions” rather than futures contracts, and thus the CFTC does not have jurisdiction over those transactions. The parties agree that if the transactions at issue were spot transactions the CFTC does not have jurisdiction. Based upon this argument, Defendants contend that the CFTC lacks jurisdiction over Counts One, Two and that part of Count Three alleging transactions during Phase I. Defendants also contend that, even assuming the transactions could be characterized as futures contracts, the CFTC has failed to establish fraud.
Relying on 7 U.S.C. § 2 (c)(2)(B)(ii)(III), the Defendants contend that Defendants Universal and QIX are affiliated persons of a Futures Commission Merchant (“FCM”); that Congress exempted such affiliated persons from the CFTC’s jurisdiction; and, thus, the CFTC does not have jurisdiction over any of the claims asserted.
*1272
In the alternative, Defendants contend that the CFTC’s jurisdiction over foreign currency transactions was limited to specified subsections which do not include the claims alleged in Counts Two, Three, and Four; the control person claims alleged in all four counts, or the principal/agent claims alleged in Counts One and Two. More specifically, Defendants Stern and Arsenault assert that they cannot be held liable for the actions of the corporate defendants as controlling persons since the Modernization Act did not make either Section 2(a)(1)(B) or Section 13(b) of the Commodity Exchange Act applicable to off-exchange retail foreign currency transactions, and because they acted in good faith and did not knowingly induce violations by any of the corporate defendants.
With respect to Count Three, Defendants contend that Section 4h of the Act, 7 U.S.C. § 6h, was omitted from the list of sections over which Congress conferred jurisdiction with respect to foreign exchange transactions, and therefore, there is no jurisdiction to enforce this provision; and, even if jurisdiction existed, the CFTC has failed to establish that either Universal or QIX falsely represented its registration status. Defendants also contend that there was no fraud or misrepresentation in the account opening documents. Similarly, Defendants contend that the CFTC does not have jurisdiction over the claim alleged in Count Four since the underlying predicate regulation, § 32.11(a), was not incorporated by the CFMA, and therefore
does not apply to foreign currency transactions.
II.
FINDINGS OF FACT
A.
The Parties and Other Relevant Entities
The CFTC filed this action in June 2004 (DE # 72, ¶ 63).
6
The CFTC is an independent federal regulatory agency that is charged with the responsibility for administering and enforcing the provisions of the Commodity Exchange Act (DE # 72, ¶ 64).
Defendant Universal FX, Inc. (“Universal” or “UFX”)
7
was incorporated in the State of Florida by Defendant Andrew Stern (“Stern”) on or about February 22, 2002 (DE # 72, ¶ 2). At the time of Universal’s incorporation, Stern was Universal’s President, Director and sole shareholder (DE # 72, ¶ 3). Universal was a trading firm that engaged in transactions in foreign currency (DE # 72, ¶ 4), and was formed with the intention of conducting retail foreign currency business (DE # 111, Stern Test, at 61). Universal used the facilities, personnel, and machinery of Universal Financial Holding Corporation (“UFHC”), and was initially capitalized by UFHC (DE #111, Stern Test, at 141). Thereafter, in approximately May 2002, Universal funded its own Futures Commission Merchant (“FCM”), which was UTS World (DE #111, Stern Test, at 142).
Prior to September 2002, Universal, while acting as the counterparty for retail transactions in foreign currency, redirected its customers’ orders to FXCM
8
for
*1273
execution (DE # 72, ¶ 11). In September 2002, Universal opened its own trading desk (DE # 72, ¶ 12). From approximately August 2002 until approximately December 2003, Universal acted as a counterparty to retail off-exchange transactions in foreign currency (DE # 72, ¶¶ 9, 14). In its role as counterparty, Universal executed customer trades, accepted customer money, and took the opposite side of customer trades (DE # 72, ¶ 10). All of Universal’s clients came from introducing brokers; except on rare occasions, the individual investors did not directly contact the trading desk (DE # 4, Ex. 2, Att. F) (Michael’s Test, at 52-53, 60-61).
9
To minimize its risk, Universal engaged in offset or hedge trading with several European financial institutions, including Dresdner Bank, Swiss Finance and IFX Markets Ltd. (DE #109 Koh Test, at 69, 106-08; DE # 4, Ex. 2, Att. F (Michael’s Test.) at 35-38, 70-77).
10
The accounts at these institutions were initially in the name of Universal Financial Holding Corp. although the money belonged to Universal FX (DE #4, Ex. 2, Att. F (Michael’s Test, at 36-38)).
Universal wholly owns UTS World, Inc., which is also a Florida corporation organized by Stern (DE # 72, ¶ 6). On May 13, 2003, UTS World first became registered as a futures commission merchant (“FCM”) (DE # 72, ¶ 7). Stern incorporated UTS World with the intention that it would act as an FCM to Universal such that Universal would be considered an “affiliated person” within the meaning of the Commodities Exchange Act and CFTC regulations (DE #49, Stern Deck, Ex. A at ¶ 7). At all relevant times, UTS World was financially dependent on Universal (DE # 49, Stern Deck, Ex. A at ¶ 8). UTS World has never held any customer-segregated funds reportable to the National Futures Association on a Form 1-FR (DE # 72, ¶ 8).
Universal Financial Holding Corporation, Inc. (“UFHC”) is a Florida corporation organized by Stern in 1994 to conduct business as a registered FCM (DE # 30, Stern Invest. Test., Ex. 1 at 13; DE 65 (NFA Detail Report and 1996 Annual Report)). UFHC deals with commodity futures and options that are traded on recognized exchanges (DE # 111, Stern Test, at 57). During the period for which Universal operated, Universal Financial Holding Corporation never held customer segregated funds of $6,250,000 or more, and had less than $5,000,000 in adjusted net capital at the end of each fiscal year during this period.
Although Universal remains in active status as a Florida corporation, it is not currently doing business (DE # 72, ¶ 5).
Defendant Sterling Trading Group, Inc. (“Sterling”) was among several other introducing entities that introduced customers to Universal (DE # 72, ¶¶ 27, 28). Sterling was incorporated as a Florida corporation by Joseph Arsenault on or about May 9, 2002 (DE # 72, ¶ 15). Sterling has
*1274
never been registered with the CFTC in any capacity (DE # 72, ¶ 16). At the time of Sterling’s incorporation, Arsenault was Sterling’s chief executive officer and sole shareholder (DE # 72, ¶ 17). At all times since Sterling’s incorporation, Arsenault has owned either all shares of Sterling, or a controlling interest of the shares of Sterling (DE # 72, ¶ 19). Arsenault had the authority to hire, and in fact hired, employees at Sterling (DE # 72, ¶¶ 20, 21). Arsenault had authority to fire employees at Sterling (DE # 72, ¶ 22). Arsenault had signatory authority over Sterling’s operating bank account, and signed most, if not all, of the checks on behalf of Sterling (DE # 72, ¶¶ 23, 24).
Sterling was active as a business from approximately August 2002 through July 2003, and solicited customers to engage in transactions in foreign currency with Universal as the counterparty (DE # 72, ¶ 25). Sterling solicited certain customers by sponsoring radio ads (DE # 72, ¶ 26). All or almost all of Sterling’s Universal accounts were discretionary, meaning that the customer authorized Sterling to trade in the customer’s account by executing a limited power of attorney (DE # 72, ¶¶ 13, 32). Arsenault personally placed most of the trades on behalf of the Sterling customers (DE # 72, ¶ 33). Sterling customers who opened an account with Universal did so by completing account opening documents provided by Universal, and transmitting funds to Universal (DE # 72, ¶¶ 29, 30). All customer funds were made payable to Universal. Universal would not accept money from Sterling or any other introducing entity, and would not accept checks made out to any introducing entity (DE # 72, ¶ 31). Universal was a party to some settlement agreements entered into with Sterling customers (DE # 72, ¶ 34).
A review of the account statements submitted as exhibits to the first Declaration of CFTC Investigator Koh reflects transactions in Euros (EUR), Swiss Francs (CHF), Japanese Yen (JPY) and British Pounds Sterling (GBP) (DE #4, Ex. 2 attachments N through Y). Customer files obtained by the CFTC indicated that Sterling had approximately 298 retail customer accounts at Universal, and that those customers invested approximately $5.6 million from January 2003 through July 2003. During that same time period, Sterling customers had trading losses (including commissions and other fees) of over $4.9 million, and customers received back approximately $734,000 (DE # 4, Ex. 2, Koh Deck at ¶ 6).
Defendant QIX, Inc. (“QIX”) is a Florida corporation that was organized on October 17, 2002 (DE # 72, ¶ 36). At all material times, Defendant Andrew Stern has been President, Director, and sole shareholder of QIX (DE # 72, ¶ 38, DE # 111, Stern Test, at 118). QIX engaged in off-exchange foreign currency options transactions (DE # 72, ¶ 37). QIX has acted as a counterparty for retail foreign currency options transactions from at least August 2003 (DE # 72, ¶ 39). The account opening documents used by QIX were put together by Daniel Perini, but ultimately approved by Stern (DE # 111, Stern Test, at 118).
QIX wholly owns QIX Futures, Inc., an Illinois corporation which has been a registered futures commission merchant (“FCM”) since November 20, 2003 (DE # 72, ¶¶ 40, 43). From the time QIX Futures first became registered as an FCM, its approved principals have been Scott Pettersen and QIX, Inc. (DE # 72, ¶ 42). Stern incorporated QIX Futures with the intention that it would act as an FCM to QIX, and that QIX would be an “affiliated person” of QIX Futures within the meaning of the Commodities Exchange Act and the CFTC regulations (DE #49, Stern Deck, Ex. A at ¶ 17). QIX Futures was
*1275
financially dependent on QIX at all relevant times (DE # 49, Stern Decl., Ex. A at ¶ 18). Prior to June 2004, QIX Futures did not conduct any business on recognized commodities exchanges (DE # 111, Stern Test, at 59). QIX Futures has never held any customer-segregated funds reportable to the NFA on a form 1-FR (DE # 72, ¶ 44).
QIX terminated its relationship with its introducing brokers and customers and closed its business when this action was filed, and transferred all of its assets to QIX Futures (DE # 49, Stern Decl. at ¶¶21, 52).
Defendant STG Global Trading, Inc. (“STG”) was incorporated in California on July 14, 2003 by Defendant Joseph Arsenault, who is the principal and controlling person of STG (DE #72, ¶ 45). STG introduced customers to QIX (DE # 72, ¶ 47). From at least August 2003 to June 2004, STG solicited retail customers to engage in foreign currency options transactions with QIX as the counterparty (DE # 72, ¶ 46). STG has never been registered with the CFTC in any capacity, but was in the process of applying for registration when this case was filed (DE # 72, ¶ 48). STG ceased doing business when this action was filed (DE # 49, Arsenault Dec. at ¶ 10).
Defendant Graystone Browne Financial, Inc. (“Graystone”) was incorporated in Florida by Defendant Arsenault on November 5, 2003 (DE # 72, ¶ 49). Gray-stone was formerly known as Global Forex Trading, Inc. (“Global” or “GFT”).
11
In November 2003, Global changed its name to Graystone Browne Financial when it received a threatening letter from an attorney who represented a company with a similar name (DE # 72, ¶ 50). Graystorie’s principal place of business at all relevant times was 18305 Biscayne Boulevard, Suite 303, Miami, Florida (DE # 72, ¶ 51).
From at least November 5, 2003, to June 2004, Graystone solicited retail customers to engage in foreign currency options transactions with QIX as the counterparty (DE # 72, ¶ 52). Graystone has never been registered with the CFTC in any capacity (DE # 72, ¶ 53). Graystone ceased doing business when this action was filed (DE #49, Arsenault Dec. at ¶ 10).
Graystone and STG both solicited customers by sponsoring radio ads (DE # 72, ¶ 59). QIX provided the account opening documents to Graystone and QIX, which, in turn, provided the documents to the customers (DE # 72, ¶ 60). The account opening documents specified how customers should transfer funds to QIX (DE # 72, ¶ 61). Customers who opened an account at QIX did so by completing the QIX account opening documents and transmitting the funds to QIX (DE # 72, ¶ 58). QIX did not accept any checks or other forms of payment, that were not made out to QIX (DE # 72, ¶ 62).
Defendant Joseph S. Arsenault (“Arsenault”) organized Sterling, Graystone, and STG (DE # 72, ¶ 15, 17, 19, 49). He was responsible for their overall management and the hiring and firing of employees (DE # 72, ¶¶ 20-24, 54-57). Arsenault was registered with the CFTC as an Associated Person or Principal of five South Florida Commission registrants at various times from 1984 through 1996 (DE # 49 Arsenault Decl. at ¶ 4; DE # 4, Ex. 2, Koh Decl. at ¶ 46). Four of these firms which were the subject of Commission enforcement actions for fraud. (DE # 4, Ex. 2, Koh Decl. at ¶ 46). However, aside from the present case, Joseph Arsenault has never been a defendant or respondent in
*1276
any other actions brought by the CFTC or the NFA (DE # 72, ¶ 18). He was previously licensed as a securities broker by the Securities and Exchange Commission and the National Association of Securities Dealers (DE # 49, Arsenault Decl. at ¶ 4).
At all relevant times, Defendant Andrew N. Stern resided in North Miami Beach, Florida (DE #30, Ex. 1, Stern Invest. Test, at 11). He is president and a director of Universal FX; president, a director and sole shareholder of QIX, Inc.; and an officer and director of UTS World, and QIX Futures (DE #49, Stern Deck, Ex. A at ¶¶2, 3). He is a registered Associated Person with the NFA, and an approved NFA associated member and sole owner of UFHC. (DE # 111, Stern Test, at 57; DE # 62, Att. B, Pendleton Deck at ¶ 4; DE # 4, Ex. 2, Koh Deck at ¶ 46). Stern has been the respondent in three NFA regulatory and four NFA arbitration actions (DE #4, Ex. 2, Koh Deck at ¶ 46).
Shortly before the hearing on the preliminary injunction, Stern entered into a settlement agreement with the National Futures Association in which he agreed that he would terminate his membership with the NFA, and would not supervise any firms that were members, but he was permitted to continue his ownership interest and to have input into financial matters concerning the firms (DE # 111, Stern Test, at 182). The settlement was based upon the vicarious liability of one of his FCMs, Universal Commodity Corporation, for the actions of an introducing broker in making misleading, deceptive and high-pressured sales solicitations, in violation of NFA rules (DE # 111, Stern Test, at 182).
Prior to this lawsuit, Andrew Stern, both directly and through counsel, had numerous conversations with Sharon Pendleton, regarding the rules and regulations applicable to foreign exchange transactions(DE #49, Stern Deck ¶ 17; DE #62, Att. B, Pendleton Deck ¶¶ 5-6). Sharon Pendleton has worked at the National Futures Association (“NFA”) since 1986, and has been an Associate Director of Compliance since 2002 (DE # 62, Att. B., Pendleton Deck at ¶ 1; DE # 101, Pendleton Test, at 15). She testified in this case as a witness on behalf of the CFTC. The NFA is a congressionally authorized self-regulatory organization of the U.S. futures industry, and Pendleton’s responsibilities there include oversight of staff who conduct audits and investigations; working on enforcement actions; advising Members on compliance issues; developing and monitoring Compliance Department goals; and serving' as a primary liaison between NFA and the CFTC in development of rules for Futures Commission Merchants and Introducing Brokers
(Id.).
She testified that she advised Defendant Stern and his counsel that she did not know whether the requirement of being a material affiliated person applied to the exemption from CFTC regulation (although she believed it did), and that she had been trying unsuccessfully to obtain written guidance from the CFTC for some time (DE # 101 at 26-34, 42-45). She also testified that it was the NFA’s position that FCMs and affiliates of FCMs were permitted to offer off-exchange options on foreign currency contracts, and that the NFA had audited members who offered such options, and did not find them to be prohibited by Regulation 32.11 (DE # 101, Pendleton Test, at 81-97). In addition, the NFA has published an interpretive notice and a retail foreign currency transactions regulatory guide which advised its members that they were permitted to conduct transactions regarding options on foreign exchange contracts (DE # 101, Pendleton Test, at 81-83). The standard procedure for issuing such guidance involves a review by the CFTC for approval (DE # 101, Pendleton Test.. at 84). The NFA rules
*1277
apply only to members, and the NFA rules relating to retail foreign currency transactions (“Forex”) became effective on December 1, 2003 (DE # 62, Att. B. Pendleton Decl. ¶ 5). To date, the CFTC has not promulgated rules specifically regarding Forex.
B.
Phase I Operations
As stated above, Phase I Operations occurred between the summer of 2002 and July 2003; and involved Forex transactions in which Sterling acted as an introducing broker, and Universal accepted the trades and acted as a counterparty.
Prior to entering the Forex market by establishing Universal, Andrew Stern met with people from two FCMs that were already engaged in this business — FXCM and Alaron (DE # 111, Stern Test, at 134). Initially, Stern entered into an arrangement with FXCM that permitted him to use their Actforex software platform to process the transactions between Universal and its customers (DE # 111, Stern Test, at 135). In addition, FXCM provided Stern with its account opening documents to use in developing Universal’s account opening documents. Universal also used parts of Alaron’s documents, including their introducing broker agreement and parts of their website (DE # 111, Stern Test, at 136). It was Stern’s intention to set up a business identical to what Alaron and FXCM were doing (DE # 111, Stern Test, at 136).
Sterling used customer account documents that were provided by Universal. There were three versions of account opening documents (DE # 4, Ex. 2, Koh Decl. at ¶ 11, and attachments A, B and C). The first version (Ex. A) was used during June, July, and August of 2002. The second version (Ex. B) was used from approximately September 2002 through early July 2003. The third version was used from on or about July 7, 2003, until Sterling ceased doing business.
Stern testified that the account opening documents for Universal were derived from the account opening documents of two existing foreign exchange firms — AlaronFX and FXCM; and that he made enhancements to them so that they would be as complete as possible (DE # 111, Stern Test, at 64-66).
Universal used the Actforex computerized trading platform, which was the same software trading platform that was used by AlaronFX and FXCM (DE # 111, Stern Test, at 152-53).
Stern testified that Universal FX offered spot cash foreign currency transactions (DE # 111, Stern Test, at 76). The account opening documents state, “trader acknowledges that the purchase or sale of currency always anticipates the accepting or making of delivery,” but no retail customers every actually took delivery of a foreign currency (DE # 111, Stern Test, at 76-77). The customers of Universal always provided Universal with U.S. dollars; and the Canadian customers were told to exchange their Canadian dollars into U.S. dollars before doing business with Universal (DE #111, Stern Test, at 77, 82). Stern testified that Universal had made arrangements to accept foreign currency from several foreign customers who contemplated large accounts, but those accounts never came to fruition (DE #111, Stern Test, at 78).
Stern' testified that customers entered into bilateral agreements with Universal under which the customer agreed to buy a particular currency at a specified price, and Universal agreed to sell the currency to the customer at that price (DE # 111, Stern Test, at 83). The customer was not required to deposit the full value of the contract, but was permitted to deposit a margin amount, which was generally two
*1278
percent (DE # 111, Stern Test, at 83). Stern testified that this was a down payment (DE # 111, Stern Test, at 83-84). The customer was required to notify Universal a day in advance if they wanted delivery, and provide sufficient funds (DE # 111, Stern Test, at 85). When a customer placed an order, Universal went to one of Universal’s foreign counter parties and obtained the currency needed to make delivery (DE # 111, Stern Test, at 86). Stern testified that the value of most of the transactions was $100,000.00 (DE # 111, Stern Test, at 88). Customers were not required to show that they had liquid assets sufficient to take delivery prior to engaging in transactions with Universal (DE # 111, Stern Test, at 89). Stern further testified that Universal had the right to increase the margin required or to liquidate or close out a customer’s position without notice at any time (DE # 111, Stern Test, at 90).
With respect to the length of time between the opening of the transaction and the settlement date, Stern testified that the account opening documents do not set a specific time, but refer to current industry customs (DE # 111, Stern Test, at 92). Stern testified that Universal used the industry custom of 48 hours, but that there was nothing in the account documents that specified this time frame (DE #111, Stern Test, at 93). Stern testified that customers could have chosen a shorter period of time, but that, based on industry custom, Universal would not have entered into an agreement for a longer period of time (DE # 111, Stern Test, at 95).
Stern’s testimony regarding the mechanics of the transactions that actually occurred was somewhat confusing.
As
stated above, he initially testified that all contracts called for a two-day settlement date (DE # 111, Stern Test, at 93). He testified that the actual rollover transactions were not reflected on account statements because of limitations in the software trading platform they were using (DE # 111, Stern Test, at 96). Stern agreed that a “rollover involves offsetting the transaction at the current market price,” and testified, “That is, in fact, what happened on the 48-hour period.” (DE # 111, Stern Test, at 96). He testified that “[w]hat happened during the rollover was the customer’s initial contract was closed out and a new contract was established.” (DE #111, Stern Test, at 96). The price was not reported to the customer on the account statement because of the above-mentioned software limitations (DE #111, Stern Test, at 96-97). He then testified that the amount of interest charged in the “premium column” of the account statement “was what we approximated that gain or loss to be” (DE # 111, Stern Test, at 98). He then acknowledged that the amount shown in the interest or premium column was a daily charge that was the same for every day (DE # 111, Stern Test, at 98). Stern attempted to explain this by stating, “If we were able to show the detail of the rollover, the amount of difference between the exiting of the one two-day position and the opening of the next two-day position [it] would have been an amount approximately in the nine- or ten-dollar range. Certainly no less than six dollars and certainly no more than 12 dollars. So by picking nine, I think we did our best to approximate what was actually happening with the physical currency.” (DE # 111, Stern Test, at 99). Stern then acknowledged, however, that for a typical transaction, the gain or a loss could easily be in the hundreds of dollars (DE #111, Stern Test, at 99). Stern then explained, “What would happen is whether the position showed the detail of the rollover or was simply mark[ed] to market, the ultimate effect on the liquidation of the account was ultimately the same. What the rollover or the interest, the interest charge was meant to approximate, was the
*1279
actual cost of getting out and getting back in. And that was never more than, as I said, you know, maybe 12 or 15 dollars.” (DE # 111, Stern Test, at 100). Stern then testified that the interest or premium charge occurred every day that a transaction remained open past 5:00 p.m. because Universal closed out every position every day (DE # 111, Stern Test, at 103-04). He then explained the significance of the two-day period as the maximum that people would go out in the industry, “but on a daily basis positions are rolled, and the value date keeps moving out for two days.” (DE # 111, Stern Test, at 105). Stern further testified that the commission was charged, in accordance with the industry customs, at the time the initial position was established, but was not charged every time there was a rollover (DE # 111, Stern Test, at 106). Stern acknowledged that there was nothing on the account statements that would permit a customer to deduce what was actually happening if the introducing broker did not explain what was happening (DE # 111, Stern Test, at 106).
Stern acknowledged that in addition to the commissions, customers were also charged varying amounts of markups that were negotiated between the customer and the introducing broker (DE # 111, Stern Test, at 106-07). The markups were part of the pricing and were reflected in the customer’s profit and loss, but were not put on the account statement the same way that a commission or interest fee was (DE # 111, Stern Test, at 108-10). Sterling included markups on both the opening and closing of transactions, generally in the amount of five pips
12
, which is the equivalent of $50.00 on a one hundred thousand dollar transaction (DE # 111, Stern Test, at 111). Other introducing brokers charged different markups; some only charged on opening transactions and others only on closing transactions (DE # 111, Stern Test, at 111). The markups were part of the internal pricing, but did not appear on customer statements until July 2003, when the software and account opening documents were revised (DE # 111, Stern Test, at 112).
Customers had the ability to sign onto the trade platform and see the current prices for various currencies; however, these prices did not include markups that would be included within any price for any transaction completed for their account (DE # 111, Stern Test, at 113). If the transaction was completed, the price shown on the account would include the markup charged by Sterling (DE # 111, Stern Test, at 114).
If a Sterling trader placed the trade online, the account statement would reflect the date and time the trade was actually made, but if the trader placed the trade by calling the phone-up desk, there would be a delay from the time called until the person who received the call processed the trade and keypunched it into the system (DE # 111, Stern Test, at 114). The time reflected on the account statement would be the time that the trade was keypunched into the system rather than the time the trade was actually placed (DE # 111, Stern Test, at 115).
Stern testified that the Actforex trading platform that Universal used only permitted foreign currency transactions in increments of a hundred thousand (DE # 111, Stern Test, at 116-17).
13
If trades were
*1280
placed by telephone rather than online, however, trades could be done for any amount since they were not restricted by the computer software limitations (DE # 111, Stern Test, at 117). Sterling chose to trade its customers with a hundred thousand increment, but other introducing brokers chose different amounts (DE # 111, Stern Test, at 118).
Stern was aware of the CFTC action filed against AlaronFX, which is known as the
Zelener
case (DE # 111, Stern Test, at 153). That action was filed on June 23, 2003. When he first learned of the case, he reviewed the problems that the CFTC had alleged with respect to AlaronFX, and tried to obviate the problems to the extent that they existed in Universal (DE #111, Stern Test, at 154). As a result of the
Zelener
case, Universal modified its account opening documents to provide details regarding the markups that would occur and how it would affect the customer’s ability to make or lose money on a trade (DE # 111, Stern Test, at 167, 169).
At any given time, the difference between the sales price and purchase price of a currency was five points or “pips,”
i.e.
.05%. That is, the price for a customer to buy currency was five points higher than the price at which the customer could sell it (DE # 111, Stern Test, at 177). The Actforex software required that all customers receive the same point spread, although the spread could be set to any amount (DE # 111, Stern Test, at 177).
Defendant Joseph Arsenault first met Defendant Andrew Stern in the early 1980’s when they both worked in the same brokerage firm (DE # 111, Arsenault Test, at 186-87). Arsenault subsequently moved to California and retired (DE # 111, Arsenault Test, at 188). In approximately 2001 or 2002, when Arsenault was on vacation in Florida, he had dinner with Stern and another individual named Joe Prager. Stern and Prager explained foreign currency trading to Arsenault. Arsenault decided to look into it, and he downloaded a practice trading platform to learn how the business worked (DE # 111, Arsenault Test, at 190-91). Prior to 2002, Arsenault had never traded off-exchange Forex, and never had a personal Forex account (DE # 111, Arsenault Test, at 191). Arsenault founded Sterling in June or July 2002, and discussed with Stern using Sterling to introduce business to Universal (DE # 111, Arsenault Test, at 191-92). The officers of Sterling were Defendant Joseph Arsenault and his father (DE # 111, Arsenault Test, at 192). Arsenault’s father did not work at the office, however (DE #111, Arsenault Test, at 192). At its peak, Sterling had 30 or 40 employees (DE # 111, Arsenault Test, at 192). The brokers contacted the clients, but did not do any trading. Arsenault did all the trading at Sterling (DE # 111, Arsenault Test, at 194-95). Universal conducted all the trades for Sterling (DE # 111, Arsenault Test, at 198). Sterling made its money through commissions and markups (DE # 111, Arsenault Test, at 204-05). Arsenault testified that without the markups the business could not have survived (DE #111, Arsenault Test, at 205-06).
Arsenault testified that to protect his clients, he put a stop order in at the same time that he placed his initial order for currency (DE # 128, Arsenault Test, at 50). It is not clear from the record how this “stop order” was implemented.
Arsenault was the direct supervisor of all sales representatives for Sterling, and
*1281
approved various radio advertisements that were used to solicit customers (DE # 128, Arsenault Test, at 7). Although Arsenault constantly kept track of how his customers were doing (DE # 128, Arsenault Test, at 57), none of the radio ads mentioned how Sterling customers were actually doing (DE # 128, Arsenault Test, at 60).
Compact disc recordings of certain radio advertisements, as well as transcripts of these advertisements are included in the record (DE # 4, Ex. 2, Koh Decl. at Att. Z(cd’s)); DE # 132 (transcripts). For example, on September 25, 2002, a person identified as Guy Davis welcomed Mr. Robert Marshall to a program called, “Business Weekly.” (DE # 132, Att. A transcript). Mr. Marshall was identified as a senior account executive with Sterling Trading Group. Mr. Marshall stated that Sterling followed currencies such as the Japanese yen, British pound, Swiss franc and Euro, and that they tried “to target the one currency that could bring us back the greatest gain potential, the greatest profit potential over the shortest period of time while always keeping your risks predetermined.”
(Id.
at 10/25/02 Tr. p. 4). Mr. Marshall explained that they recommended a $10,000.00 investment, which would allow the customer to leverage a purchase of approximately 500,000 Euros. If the Euro moved up 7 cents, the customer could see a return of as much as $35,000.
(Id.
Tr. at 7). In responding to a question regarding the risk of becoming involved in the currency market, Mr. Marshall stated that, “We never want to sweep that under the rug. Our traders place stop-loss orders on every trade in order to reduce the inherent risk of trading in the currency market place.”
(Id.
at Tr. p. 10). Mr. Marshall then stated that the loss was therefore pre-determined when the trade was placed
(Id.).
Mr. Marshall urged listeners to “stop whatever it is you’re doing now, put down your pen, put down your notebook, pull your car over to the side of the road. Call this number.” He then provided the toll free number for Sterling
(Id.
at 16). Mr. Marshall also explained that customers could leverage other currencies such as the Japanese yen and purchase 100,000 yen per contract
(Id.
at 18). Mr. Marshall then confirmed that, “if the Euro currency went from 95 [cents] to 100, moved up 5 cents, on five contracts, and [you] caught that whole move, you would make $25,000”
(Id.
at 25). However, if the Euro went down five cents, Mr. Marshall explained that the investor would not lose $25,000 because of the stop-loss orders. As an example, he stated that if you purchased 100,000 Euros at 95, a stop-loss order placed at 94.60 would mean that you would lose only $400.00 per contract, for a total of $2,000.00 on five contracts
(Id.
at 26-27).
Based upon a review of the radio advertisements, the undersigned finds that Sterling was marketing speculative invest-m'ents in foreign currency in which there was great potential for gains and the ability to pre-determine and limit the potential loss.
14
The earlier' advertisements discussed the purchase and sales of contracts by customers; the later advertisements referred to the purchase and sale of “pure” currency (DE # 132, Att. F. (3/31/03 Tr.) at 19), but none of the advertisements
*1282
contemplated that the customer would take delivery of the currency, particularly within 48 hours. For example, one radio ad discussed the increase in the value of the Euro over a one month period, claiming that the Euro had increased from 102 to 109 during the preceding 30 days, and that if the investor had opened an account with $12,000.00 and purchased 6 contracts 30 days ago, he could have made $42,000.00 in one month (DE # 132, Att. D at 22-23). That same advertisement explains that an investor who puts $2,000.00 in the market controls $100,000.00 in leverage, but that the customer doesn’t “physically own that” (DE # 132, Att. D at 27). Similarly, the radio ad on March 20, 2003, discussed the concept of leverage and controlling a $100,000.00 contract with a “margin or a good-faith deposit of $2,000.00,” and stated that the investor didn’t “actually own that $100,000” but was “just using it” (DE # 132, Att. E (3/20/03 Tr.) at 3). In discussing risk, the ad states that they would “risk somewhere in the neighborhood of one third to 40 percent of that on any given trade” (DE # 132, Att. E (3/20/03 Tr.) at 4-5). The ad then explained that the investor bought a contract that was not an option, and not a put or a call, and that there was no time value or expiration; rather, “This is the cash or the spot currency market. This is not futures. It’s not options.” (DE # 132, Att. E (3/20/03 Tr.) at 5-6). The ad also explained that Sterling charged a “$150 round turn commission” which means you only pay one way, and that Sterling didn’t take any of the profit from the trades (DE # 132, Att. E (3/20/03 tr.) at 8). This ad also disclosed an “interest” charge of about $5 per night if there is a trade over 24 hours (DE # 132, Att. E (3/20/03 Tr.) at 9).
The ads claimed that the traders, customers and clients were very happy, but did not disclose the significant losses that customers were suffering
(See
DE # 132, Att. F (3/31/03 Tr.) at 32, “Not only am I very happy with the success of Sterling Trading Group and our traders, but our investors and our clients are very happy with the return on their investments.”). Later advertisements included the $150 commission that would be charged, and stated that it would be “per contract,” “to buy and to sell,” and that there was “nothing else” charged (DE # 132, Att. F at 28). Like the earlier ads, the March 31, 2003 ad emphasized that a $12,000.00 investment would buy six contracts, and that if there was a two penny move in the market, the investor would double his money, less the $150 per contract commission for each of the six contracts (DE # 132, Att. F (3/31/03 Tr.) at 38-39).
Each of the ads repeatedly advised the listener to call the toll-free number to speak to a Sterling representative and obtain an information package.
Arsenault’s control over operations at Sterling included providing sales scripts for his salespersons to use, and using a “barge” system which allowed him to monitor the conversations between his salespersons and customers (DE # 128 at 9).
Sterling customers Phillip Matthews, Robert Firebaugh, Gregg McNelley, and Anthony Chentnik, as well as NFA employees Bridget Freas and Shamika Wade, provided sworn Declarations and testified regarding the information on foreign exchange currency trading that they received from representatives of Sterling. The undersigned credits their testimony, and finds that Sterling representatives routinely touted the profitability of investments, while failing to disclose the losses being suffered by customers or the mark-ups that would be included in their transactions; that none of the customers intended to take delivery of the currency; and that all of the customers invested for the purpose of speculation.
*1283
Arsenault testified that Universal was the counterparty to the transactions of his customers; but also testified that Universal would not take the opposite side of Sterling’s transactions unless Universal could hedge the trades overseas (DE # 111, Arsenault Test, at 199-200). Therefore, “if Universal sold a contract, then a Sterling customer would purchase that contract” (DE # 111, Arsenault Test, at 200). Arsenault testified that if his clients stayed in a position after 5:00 p.m., they would be charged interest, and that contracts were rolled over every 48 hours unless they were closed out (DE # 128, Arsenault Test, at 22). Arsenault was the person who made the decision whether to close out transactions (DE # 128, Arsenault Test, at 22).
Arsenault claimed that he could have placed trades through other affiliates of FCMs, such as Alaron or FXCM, but he chose to use Universal because Stern was the one who had brought this business to his attention (DE # 111, Arsenault Test, at 198).
With respect to the decision to disclose markups, Arsenault testified that, after the
Zelener
case was brought, it was his decision to change the account documents to more fully disclose the markups (DE # 111, Arsenault Test, at 206-07).
Arsenault testified that he decided to close Sterling because “after a year I realized there’s no way anybody could make any money ... in the spot
15
market” and so he sent the clients a letter stating that the market was too volatile, their money was being returned, and he was shutting down the business (DE # 111, Arsenault Test, at 207-08).
16
The Account Opening Documents
Since the three versions of the account opening documents are, in large part, identical; and, since at least the majority of Sterling’s customers signed the second version, except as otherwise specified, all references in this discussion are to the second version (DE # 4, Ex. 2, Koh Decl. at Att. B). Each package contained a Risk Disclosure Statement that was taken verbatim from 17 C.F.R. § 1.55 (c), Appendix A, which is a generic risk disclosure statement, which begins with the statement, “This brief statement does not disclose all of the risks and other significant aspects of trading in futures and options. In light of the risks, you should undertake such transactions only if you understand the nature of the contracts (and contractual relationships) into which you are entering and the extent of your exposure to risk. Trading in futures and options is not suitable for many members of the public.” It then contains specific sections under the headings, “Futures,” “Options,” and “Additional risks common to futures and options.”
(Id.,
at pp. 101 00058-59)
Following the Risk Disclosure Statement is a Customer Information form which seeks certain biographical, trading experience and financial information concerning the customer
(Id.
at p. 101 00060).
The next document in the package is entitled, “Notice to Traders.” The first line of this Notice is centered, and states, “This Agreement Is a Legal Contract, Please Read It Carefully”
(Id.
at pp. 101 00061-62). The contract is between Universal FX (referred to in the contract as “UFX”) and the customer. In pertinent part, this contract has the following provisions:
*1284
In connection with opening an account to speculate and/or purchase and/or sell cash or spot foreign currency (hereinafter referred to as “Currency”) through the OTC foreign exchange markets (hereinafter referred to as “OTCFX”) with UFX, Customer (hereinafter referred to as Trader) acknowledges that Trader has been advised and understands the following factors concerning trading in leveraged OTCFX, in addition to those contained in the Risk Disclosure Statement which has been provided to Trader.
1. OTCFX is not traded on a regulated exchange. There are no guarantees to the credit worthiness of the counter party of your Currency position. Every attempt has been made to deal with reputable credit worthy banks/clearing houses. Also, there may be certain cases in which trading liquidity decreases causing trading in a certain Currency to cease, thereby preventing the liquidation of an adverse position that may result in a substantial financial loss.
2. Trading in OTCFX is suitable only for those sophisticated institutions or sophisticated participants financially able to withstand losses that may substantially exceed the value of margins or deposits....
3. Trader acknowledges that the purchase or sale of a Currency always anticipates the accepting or making of delivery.
4. UFX’s margin policies and/or the policies of those banks/clearing houses through which trades are executed may require that additional funds be provided to properly margin Trader’s account and that Trader is obligated to immediately meet such margin requirements. Failure to meet margin calls may result in the liquidation of any open positions with a resultant loss. UFX also reserves the right to refuse to accept any order.
5.OTCFX business is not traded on a regulated market....
6.....
b) Market risks and on-line trading Trading currencies involves substantial risk that is not suitable for everyone. See Trader Agreement for more detailed description of risks....
7. In OTCFX, firms are not restricted to effect off-exchange transactions. The firm with which you deal may be acting as your counter party to the transaction. If may be difficult or impossible to liquidate an existing position, to assess the value, to determine a fair price or to assess the exposure to risk..... Off-exchange transactions may be less regulated or subject to a separate regulatory regime....
8. In the event that Trader grants trading authority or control over Trader’s account to a third party (Trading Agent), whether on a discretionary or non-discretionary basis, UFX shall in no way be responsible for reviewing Trader’s choice of such Trading Agent or for may any recommendations with respect thereto.....
The next document in the package is entitled, “Trader Agreement”
{Id.
at pp. 101 00063-68). It provides, in pertinent part:
In consideration of UFX agreeing to carry one or more accounts of the undersigned (“Trader”) and providing services to Trader in connection with the purchase and sale of cash currencies (including financial instruments) and any similar instruments (collectively referred to as “OTCFX”), which may be purchased or sold by or through UFX for Trader’s accounts(s)[sic ], Trader agrees as follows:
1. AUTHORIZATION TO TRADE. UFX is authorized to purchase and sell OTCFX for Trader’s account(s) with a
*1285
counter party bank or sophisticated institutions or participants in accordance with Trader’s oral or written or computer instructions. Unless instructed by Trader to the contrary in writing, UFX is authorized to execute all orders with such banking institutions, counter party, bank, or sophisticated institutional participants as UFX deems appropriate.
3. MARGINS AND DEPOSIT REQUIREMENTS. Trader shall provide to and maintain with UFX margin in such amounts and in such forms as UFX, in its sole discretion, may require. Such margin requirements may be greater or less than margins required by a counter party bank. UFX may change margin requirements at any time. Trader agrees to deposit by immediate wire transfer such additional margin when and as required by UFX.... UFX may at any time proceed to liquidate Trader’s account in accordance with paragr

[Text truncated at 120,000 characters. The full text is on the page linked above.]

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/2511506. Public record. Not legal advice.