Petition — British American Commodity Options Corp. v. Bagley

Supreme Court brief1977

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Text

. Supreme Cou, Ug oa

Pies Treg

JUL 15 197

MICHAEL RODAK, Jp,, CLERK

In THE

Supreme Court of the United States

October Term, 1977

ee 77-96 +

Bartiso American Commopity Options Corp.

and Liwyp, Care & Co.,

Petitioners,

—against—

Wuuum T. Bacizy, Chairman of the Commoprry Futures

Trapine Commission ; Joun V. Rarnsorr III, Vice Chair-

man of the Commopiry Furvres Trapinc ComMMIssIon ;

Reap P. Dunx, Gary Szeevexs, and Roserrt L. Martin,

Commissioners of the Commopiry Futures Trapine

ComMMIssION,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Cuarizs J. Heour

Attorney for Petitioners

60 East 42nd Street

Suite 1760

New York, New York 10017

(212) 490-3232

INDEX

PAGE

Official and Unofficial Reports of the Opinions Below 1

FOE TNS TO LOE SES EDA NN TI TERS A, ATOR 2

The Questions Presented for Review ...........................- 3

Constitutional Provisions, Statutes and Regulations

Soc ieee eT ceheesannasonscetiaasanbiin 4

EE OE RENE SES SEO On TRS OCS NCC 4

Reasons for Granting the Writ —..........2022222- ee... 6

RR TCT 8

ie I a sseteiansemntiinnnnctona 9

EE EE eC 15

IV.. Anti-Trust Considerations .............0..00............. 17

I a On esuincbihinens 19

I a sl seebesintabins 21

SUPPLEMENT .................... Sy PORES Si eS oe vO 22

Appenpix A—

Memorandum and Order ...........................................-. la

ApPenprx B—

I cast enact atciahemesemaniiin 27a

Appenpix C—

Opinion of Court of Appeals —.....0..............-.-.--- 29a

PAGE

Aprenpixx D—

Order of Court of Appeals Dated June 8, 1977 .... 53a

Aprenpx E—

Order of Court of Appeals Dated June 14, 1977 .... 55a

Appenpx F— |

Principal Statutes Involved 57a

Aprenpix G—

Principal Regulations Involved ................... 60a

Aprenpixx H—

Senne O0iT GUIIIIIID ._.....ssanssenassuniubniitinennineliinineimagiiaidenaiitis 66a

Appenpix I[—

Order Granting Injunction Pending Appeal ........ 72a

lii

TaBLE oF AUTHORITIES

CasEs PAGE

CFTC v. British American Commodity Options Corp.,

422 F.Supp. 662 (S.D.N.Y. 1976) : ae 15

CFTC v. Lloyd, Carr @ Co., et al. (77-371 T D.C.

Ea ei SEN eT 16

CFTC v. J.S. Love Associates Options, Ltd., 422 F.

Gk Ene CE 20

CFTC v. Rosenthal ¢ Co., 76 Civ. 3094, U.S.D.C., N.D.

SR es cemenunianeaneds 10

Citizens to Preserve Overton Park v. Volpe, 401 U.S.

Se IN sscedbiiiiceeittiaed-dekehcectndidintsidligeictdasindasacbaborntantemntieasons 19

Doran v. Salem Inn, Inc., 422 U.S. 922 (1975) 0... 4, 20

Goldberg v. Kelly, 397 U.S. 254 (1970) 0000... ae 17

Hecht v. Pro-Football, Inc., 444 F.2d 931 (D.C. Cir.

1971), cert. denied, 404 U.S. 1047, 92 S.Ct. 701, 30

gS 18

Hornsby v. Allen, 326 F.2d 605 (5th Cir. 1964) 00... 17

Overseas Media Corp. v. McNamara, 385 F.2d 308 (D.C.

Ta atl 18

Pan Atlantic Steamship Corp. v. Atlantic Coastline

Railroad Co. et al., 353 U.S. 436 (1957) 200... 16

Pillai v. C.A.B., 485 F.2d 1018 (D.C. Cir. 1973) ............ 18

Progress Development Corp. v. Mitchell, 286 F.2d 232

(7th Cir. 1961) .......... weedy 21

Sonesta Int’l. Hotels Corp. v. Wellington Associates,

463 F.2d 247 (2nd Cir. 1978) 2. ...en.2..n..ccencececcveesee- 20

PAGE

United States v. Florida East Coast Ry. Co., 410 U.S.

224 (1973) ....... ae 4, 7,19

Yick Wo v. Hopkins, 118 U.S. 356 (1886) ............... weniaaas 17

StTaTUTES

EEE 4, 5, 19, 20

GD WARD, GD ccccecesisssrsccnssncittittianiticitustinesstiommiiaaaaaiaae 4,5, 19

ga) ae 8, 12, 15, 19

Bf): 2 ae 3,5, 7,17

Bis ty ee 3

ConsTITUTIONAL PROVISION

United States Constitution, Fifth Amendment .............. 4,5

C6 ewes ees ae.

In THE

Supreme Court of the Auited States

October Term, 1977

British American Commopity Options Corp.

and Luoyp, Carr & Co.,

Petitioners,

—against—

Wnutam T. Bactzy, Chairman of the Commopiry Futures

Trapine Commission ; Joun V. Rarnsorr ITI, Vice Chair-

man of the Commopiry Futures Trapinc Commission;

Reap P. Duns, Gary Szevers, and Rosert L. Martin,

Commissioners of the Commoprry Fururss Trapine

ComMIssION,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Petitioners pray that a writ of certiorari issue to review

the judgment of the United States Court of Appeals for

the Second Circuit entered on April 4, 1977, as amended

on May 11, 1977.

Official and Unofficial Reports of the Opinions Below

This case originated by the filing of a complaint by the

plaintiffs British American Commodity Options Corp.

(“British American”) and Lloyd, Carr & Co. (“Lloyd,

Carr”) in the United States District Court for the Southern

District of New York. Subsequently, an action was insti-

tuted in the United States District Court for the District

of Columbia by the National Association of Commodity

Options Dealers (“NASCOD”) and certain constituent

members.' The Honorable Whitman Knapp consolidated

the two cases and rendered a decision granting plaintiffs’

motion for a preliminary injunction as to (32.6 of the regu-

lations (commonly called “double segregation”) and grant-

ing defendants’ motion for summary judgment with re-

spect to all other aspects of these regulations. Copies of

the trial court’s Memorandum and Order and subsequent

Order and Judgment appear as Appendices A and B. The

case was unofficially reported in the CCH Comm. Fut. L.

Rep. 720,245.

All parties appealed the case to the United States Court

of Appeals for the Second Circuit. That Court rendered

a judgment affirming the District Court except for the

grant of injunctive relief against the double segregation

requirement set forth in §32.6 of the regulations, which it

reversed. The Opinion of the Circuit Court is officially

reported in 552 F.2d 482 and is unofficially reported in

CCH Comm. Fut. L. Rep. 720,400. A copy of this Opinion,

as subsequently amended, appears as Appendix C.

Jurisdiction

The Opinion and Judgement of the Court of Appeals,

printed in Appendix C hereto, which incorporates the

? British American Commodity Options Corp. and Lloyd, Carr

& Co., were named in such suit without their knowledge and con-

sent. Counsel for NASCOD filed a motion with the United

States Court of Appeals for the Second Circuit to delete such

companies as party plaintiffs in that action. NASCOD requested

and on July 8, 1977 obtained an extension to file its Petition for a

Writ of Certiorari.

ee eee

amendment to the Opinion dated May 11, 1977, was entered

on April 4, 1977. The Petitioners’ request for reconsidera-

tion was denied on June 6, 1977. A copy of that order is

printed in Appendix D hereto. On June 14, 1977, the Court

of Appeals stayed its mandate in accordance with Rule

41(b) of the Federal Rules of Appellate Procedure. A

copy of this order is printed in Appendix E hereto.

The jurisdiction of this Court is invoked under 28 U.S.C.

§1254(1).

The Questions Presented for Review

1. May a governmental agency lawfully charged with

regulating an industry adopt an arbitrary and unreason-

able regulation with which no member of that industry

can comply?

2. May a governmental agency impose and enforce a

new licensing scheme which permits it arbitrarily by mere

inaction to deprive existing licensed dealers, who meet all

the objective standards for licensing, the right to continue

to do business without any due process?

3. May a governmental agency impose and enforce this

licensing scheme to deny existing employees in this indus-

try the right to earn a livelihood by the mere failure to

process their individual registration applications?

4. May a governmental agency impose a licensing

scheme which has the effect of preventing entry into this

industry of companies and persons who meet all of the

objective standards set forth in the pertinent statute and

regulations promulgated thereunder?

5. May a governmental agency disregard a specific anti-

trust statute (7 U.S.C. §19) governing that agency’s rule

making powers by estavlishing a concededly anti-competi-

tive regulatory scheme without any substantial benefit to

the public interest?

6. Did the United States Court of Appeals for the

Second Circuit improperly extend United States v. Florida

East Coast Ry. Co., 410 U.S. 224 (1973), in permitting a

governmental agency to adopt pervasive new regulations

affecting a substantial industry without any meaningful

opportunity for that industry’s participation in the regu-

latory process, as required by 5 U.S.C. §553(c) ?

7. Did the lower court, and especially the Second Cir-

cuit, use the wrong standard in contravention of Doran v.

Salem Inn, Inc., 422 U.S. 922 (1975) in denying plaintiffs’

request for a preliminary injunction?

Constitutional Provisions, Statutes and

Regulations Involved

The constitutional provision involved is the due process

clause of the Fifth Amendment to the United States Con-

stitution. The statute giving the District Court power to

issue the injunction is 5 U.S.C. $706. The rule giving the

District Court discretion to enter the injunction is Rule 65

of the Federal Rules of Civil Procedure. The statutory

provisions are printed in Appendix F hereto. The prin-

cipal portions of the regulations involved are printed in

Appendix G hereto.

Statement of the Case

Petitioners, British American and Lloyd, Carr, are, re-

spectively, the largest and the second or third largest com-

panies, in the United States specializing in the retail sale

ee ee

led ee WS

of London commodity options to the general public. As a

result of regulations published in the Federal Register on

October 8, 1976 (41 Fed. Reg. 44560), petitioners filed a

complaint. After a hearing was scheduled the Commodity

Futures Trading Commission (the “CFTC”) advised the

District Court that it was withdrawing these regulations.

On November 24, 1976 the CFTC published new regu-

lations (41 Fed Reg. 41565). Petitioners filed an amended

complaint seeking declaratory relief with respect to the

legality and constitutionality of these regulations under

5 U.S.C. §553, 5 U.S.C. §706, 7 U.S.C. §19 and the Fifth

Amendment to the United States Constitution. After the

District Court scheduled a hearing on petitioners’ motion

for a preliminary injunction another suit questioning these

regulations was filed in the United States District Court

for the District of Columbia, which on motion of NASCOD’s

counsel was consolidated with this action.

As set forth in printed Appendix A hereto the District

Court granted plaintiffs’ motion for a preliminary injunc-

tion with respect to Section 32.6 of the regulations (“double

segregation”), specifically finding that double segregation

is arbitrary and unreasonable and would immediately force

all existing specialty dealers out of business. The District

Court granted defendants’ cross motion for summary judg-

ment with respect to the legality and constitutionality of

the other portions of these regulations. The Court of Ap-

peale for the Second Circuit reversed the preliminary in-

junction as to Section 32.6 and affirmed the District Court’s

decision with respect to the balance of the regulations. Al-

though the Circuit Court denied petitioners’ request for

reconsideration, they granted petitioners’ motion for a stay

of mandate pending filing a petition for a writ of certiorari.

Reasons for Granting the Writ

This case satisfies all of the traditional prerequisites

for granting a writ of certiorari.

1. This is the first case to be presented to the Su-

preme Court with respect to a recently created federal

regulatory agency.

2. The pervasive regulatory scheme contains a

number of unique provisions which have never been

considered by the Supreme Court.

3. The questions are close, complex, difficult and are

of widespread importance. Their resolution will have

an immediate and substantial impact on all existing

firms selling London commodity options, their thou-

sands of employees and the existing rights of over

100,000 beneficial owners of commodity options, the in-

vesting public in general, as well as, trade relations

with Great Britain.

4. There is substantial disagreement amongst the

lower courts with respect to the legality and constitu-

tionality of double segregation which should be

promptly resolved by the Supreme Court. Subsequent

to the Second Circuit’s reversal of the District Court’s

ruling on double segregation the United States Dis-

trict Court for the Northern District of Georgia (At-

lanta Division) found the Second Cireuit’s opinion

unpersuasive and granted a specialty dealer a pre-

liminary injunction pending appeal. The Order and

Opinion of that Court are printed as Appendices H

and I hereto.

5. Under the licensing portion of the challenged

regulations the CFTC is unconstitutionally empowered

to deprive the petitioners as well as thousands of exist-

ing employees of all specialty dealers and numerous

individuals who want to become employed in this in-

dustry from earning a livelihood. The Court should

promptly rectify this serious injustice.

6. This is the first case to reach the Supreme Court

which presents the issue of whether a federal regula-

tory agency may disregard a Congressionally man-

dated anti-trust policy [7 U.S.C. §19] directed to the

agency’s authority to promulgate rules and regu-

lations.

7. This case also squarely presents the constitu-

tional issue of whether the Supreme Court should ex-

tend United States v. Florida East Coast Ry. Co.,

410 U.S. 224 (1973) to sanction the denial by a federal

regulatory agency of any meaningful participation by

the regulated parties in the formulation of new reg-

ulations which will have a substantial impact on the

industry, its existing customers and the investing pub-

lie in general.

8. The Second Circuit’s approach to the propriety

of the denial of a motion for a preliminary injunction

by summary judgment directly conflicts with the hold-

ing of the Seventh Circuit Court of Appeals in Prog-

ress Development Corp. v. Mitchell, 286 F.2d 232 (7th

Cir. 1961) and the criteria for granting or denying a

preliminary injunction as set forth by the Second

Circuit and the Supreme Court of the United States.

I. General Background

For the convenience of the Court, set forth below is a

brief synopsis of the background underlying this litigation.

As a resuli of the Goldstein, Samuelson situation in 1971,

which involved the sale of naked options, i.e. where the

dealer never purchased the option in London, the Com-

modity Exchange Act was amended in 1974 to create a

new agency, patterned after the Securities and Exchange

Commission, to regulate transactions in commodity futures

contracts and commodity options. At the present time,

the business transacted by the petitioners is limited to

the purchase and sale of commodity options on the Inter-

national Commodity Clearing House (the “ICCH”) and

the London Metals Exchange (the “LME”) in London,

England.? Under the Commodity Exchange Act of 1974,

as amended, (“the Act”), 7 U.S.C. §6e(b), the CFTC was

given the authority to promulgate rules or regulations re-

lating to commodity option transactions. Initially, in 1975,

the CFTC adopted a broad anti-fraud rule which is ap-

plicable to London commodity options. Thereafter on

October 22, 1975, the office of General Counsel of the CFTC

issued an interpretive letter requesting that al} London

commodity option dealers, and their principals, but not

the sales employees thereof, register with the CFTC as

commodity trading advisers (“CTA”).

As a result of such legislation a new specialty invest-

ment industry was created which as of the time the recent

regulations were adopted consisted of approximately 70

companies with over 5,000 employees and approximately

* At the present time there is no mechanism for trading in

domestic commodity options. New regulations have been proposed

with respect thereto (42 Fed. Reg. at pp. 18262 et seq. April 5,

1977).

100,000 customers. On February 20, 1976, the CFTC pub-

lished proposed regulations relating to commodity option

transactions (41 Fed. Reg. Vol. 41, No. 35) which were

totally different from the regulations finally adopted. Sub-

sequently, the CFTC formed an Advisory Committee,

which failed to include any member of the London com-

modity options industry. On October 8, 1976, the CF'T'C

published in the Federal Register an extensive set of new

regulations relating td commodity options transactions.

These were withdrawn and on November 24, 1976 the

CFTC published revised regulations relating to commodity

option transactions.

II. Double Segregation

The most controversial section of the new regulations

is Section 32.6 (“double segregation”) which requires that

each dealer segregate in a special account 90 percent

of all customer funds received until the customer’s option

is either exercised or abandoned. Ethical dealers, such as

the petitioners, unlike Goldstein, Samuelson, actually pur-

chase the option on the ICCH or LME. Accordingly, under

double segregation the petitioners would also be required

to transmit their own funds, normally equal to approx-

imately 70% of the customers total purchase price, to

London to purchase the option for the benefit of its cus-

tomer. Annexed hereto as a supplement is a table setting

forth a cash flow analysis, based on the income statement

of British American furnished to the lower courts, of one

option transaction without the imposition of double seg-

regation. Under double segregation using an option that

costs the customer $2,250 the dealer would be required to

segregate in a special bank account $2,025, leaving a bal-

ance of $225. The dealer would then be required to expend

the following:

(a) To purchase the option $1,550.00

(b) Sales commissions 236.00

Tora. $2,034.34

Thus, everytime a dealer sells an option he creates an

approximate 900% negative cash flow and a cash deficit

of $1,809.34. As hereinafter explained in detail dealers

cannot use the $2,025 placed in the segregated account as

collateral to finance the purchase of the option or its

operating expenses.

The London exchanges, and in particular the ICCH,

have set up extensive safeguards to ensure that when the

beneficial owner of the option elects to exercise the option,

the option will be exercised. The record is uncontroverted

that during the last 125 years there has never been a de-

fauit on either of these two exchanges.

To this writer’s knowledge, there is not one firm pres-

ently engaged in the retail sale of commodity options who

can comply with double segregation and, unless enjoined,

participation in this industry by existing members will be

limited to two firms, Rosenthal & Co., and International

Trading Group, both of whom were granted limited ex-

emptions.* These exemptions were granted pursuant to

Section 32.4(b) of the regulations, which are absolutely

devoid of any standards or criteria. Accordingly, the

® Rosenthal & Co., a diversified commodities dealer, which is

substantially larger than British American, whose primary busi-

ness is the sale of domestic futures contracts, recently consented

to a preliminary injunction for alleged violations of the anti-fraud

rules relating to its sale of commodity options (CFTC v. Rosenthal

& Co., 76 Civ. 3094 U.S.D.C., N.D. IIL, Eastern Div.).

CFTC has the “right”, which it has exercised, to abitrarily

select which firms will be permitted to remain in business.

The rationalization put forth by the CFTC and ap-

parently accepted by the Second Circuit is that “financially

stable firms may be able to meet the capital requirements

of segregation by borrowing and using the interest they

can obtain on the segregated funds to defray a good part

of the cost of borrowing.” The District Court specifically

found that the CFTC’s suggestion that double segregation

could be complied with by bank financing was not per-

suasive (footnote 29a). Moreover, the Second Circuit’s

interpretation ignores the minimum capital requirement

($50,000) set forth in the new regulations and renders it

totally meaningless. In fact, the dealers in this industry,

including the petitioners, who far exceed the minimum

financial requirements adopted by the CFTC, have vainly

attempted to obtain financing and as of the date hereof

no one has been successful. The basic reason is that the

financing requirements for each dealer will run anywhere

from eight million dollars to thirty million dollars. Cus-

tomers’ segregated accounts by definition are not accept-

able collateral to a lending institution as the purported

purpose of a segregated account is to give the customers a

first lien on these funds. Thus, for example, British Amer-

ican which has a net worth in excess of $500,000 is unable

to obtain the financing needed to comply with double seg-

regation, estimated to be in excess of twenty million dol-

lars. The CFTC admitted before the District Court that

only four or five of the largest diversified securities and

commodity dealers with substantial capital over and above

the capital requirements of their other lines of business

would be able to shoulder the “double segregation” burden.

The Second Circuit adhered to the CFTC’s contention

that double segregation is required as a minimal protective

measure to ensure fulfillment of the option transaction,

although the record discloses that the CFTC’s Advisory

Committee recognized that double segregation may not

protect customers or be legally effective under the bank-

ruptey law (A 139, 157).* Since the CFTC has never at-

tempted to obtain appropriate clarifying legislation with

respect to the bankruptcy act, it is doubtful that double

segregation while having a devastating impact on the in-

dustry can even accomplish its purported basic goal.

The gist of the Second Circuit’s opinion, especially as to

double segregation, appears to be that since the CFTC

could have banned trading in commodity options entirely,*

so long as it “considered” various alternative approaches,

whatever it adopted short of abolition was not arbitrary

or unreasonable.

Furthermore, in legitimizing double segregation the

Second Circuit over-looked the difference between a com-

modity futures dealer who can net out other customers

futures contracts or, in the case of a securities broker-

dealer, utilize customers’ securities on margin, to finance

the purchase of a commodity futures contract and a dealer

specializing in commodity options who is not permitted to

‘Such a prohibition would have been contrary to the findings

of the CFTC’s own Advisory Committee. In arriving at its deci-

sion the Second Circuit e certain crucial factual assumptions

which were either wrong or not supported by the record, to wit:

(i) this was a previously unregulated industry when, in fact, com-

panies had been required to register under 7 U.S.C. §6(n) and

were subject to numerous regulations, including a broad anti-fraud

rule; (ii) assuming that commodity options are less expensive

than futures contracts and thus are peculiarly attractive to in-

dividual investors of relatively modest means with a propensity

for taking risks and, that option investors thus need more protec-

tion when, in fact, futures contracts are purchased on 5% to 10%

margin and, thus require a far smaller initial investment and are

much more leveraged than commodity options.

* Record on Appeal.

net out customers positions or otherwise use its customers

equity as collateral to secure the requisite financing.*

The purchase of the options with the dealer’s funds can

only be financed independently of the specialty dealer’s

operations as there is no legitimate business which oper-

ates at 90% after-tax profits. The denial of the use of

operating revenues for a substantial period of time would

be ruinous. The Second Circuit Court’s statement that “it

[double segregation] threatens to restrict participation in

the industry to soundly capitalized firms” is an under-

statement. British American and Lloyd, Carr, as well as a

number of other dealers, have capital far in excess of what

is required by Regulation 1.17 but are totally unable to

comply with the double segregation requirements.

The CFTC’s justifications for double segregation are

not supportable. The imposition of double segregation,

even assuming appropriate financing were available, would

encourage fraud and unfair dealing, and would be prej-

udicial to the customer:

(a) It would encourage naked options, which are

not presently prohibited, which was the sole and/or

principal cause of the Goldstein-Samuelson, J.S. Love

and United Kingdom situations. Obviously, if naked

options are sold, the dealer must recommend options

on which he believes his customer will lose money in

order to stay in business. The dealer is betting

against the customer. Moreover, since the dealer is

not transmitting the funds to buy an option in London,

* Efforts to obtain financing through major broker-dealers have

also proved fruitless since the enormous amounts of capital so

loaned would be a charge against capital and thus could place

them in violation of the SEC net capital rule and the NYSE net

capital requirements.

the adverse financial impact of double segregation is

effectively avoided. In short, the CFTC is now en-

couraging the very method of doing business which

_caused the Goldstein, Samuelson debacle. It is con-

ceded on the"?ecord that the petitioners do not deal in

naked options.°

(b) Alternatively, dealers would be required to

recommend very short term options which would sat-

isfy the best interests of the dealer in that segregated

funds would be promptly released but would be gen-

erally contrary to the best interests of the customer.

It is elementary that the longer the option period the

better chance the customer has to realize a profit. Com-

modity options are not short term trading vehicles

resulting in a substantial number of commissions to

the dealer.’

stantially, which the CFTC concedes but apparently

justifies in the name of the additional protection sup-

posedly afforded by double segregation. It is esti-

mated that these direct costs could be in excess of

$200 per transaction.

In summary, double segregation violates every tenet of

business and common sense.

6 Both British American and Lloyd, Carr have taken the posi-

tion that they will not sell naked options and believe that except

under unusual circumstances, 30-day options are not a suitable

investment vehicle from the customer’s point of view.

7 Under Reg. 1.17(¢)(2) funds segregated with respect to op-

tions with an expiration date of a year or more are not includible

as a current asset for working capital purposes.

Ill. Registration

Under 7 U.S.C. §§6f and 6k* and Section 32.3 of the

regulations all existing dealers and sales employees were

required to be registered, as distinguished from filed, by

January 17, 1977. There is no statutory or regulatory re-

quirement that the CFTC timely or properly process these

applications. In January 1977 the CFTC took the arbitrary

position that it was under no obligation to process within

the foreseeable future any application filed after Decem-

ber 27, 1976.° .

The CFTC’s interpretation of this regulation as to

Lloyd, Carr, which was already registered as a CTA rep-

resents the ultimate due process “Catch 22”. Lloyd, Carr

filed its application as a futures commission merchant

(“FCM”) on October 1, 1976. As of January 17, 1977 the

CFTC had not acted upon its FCM application. The CFTC

staff then ordered Lloyd, Carr to immediately cease all

operations since it was not yet registered as an FCM

leaving Lloyd, Carr with Hobson’s choice of shutting its

doors immediately or being deemed unfit to be registered

if it continued to do business. Although the CFTC’s

*7 U.S.C. §6n, which relates to a CTA, unlike Section 32.3 and

the above statutes, contains a prescribed time period within which

the staff must act with respect to a registration application. Prior

to the institution of this litigation a federal court held that the

CFTC’s failure to expeditiously proceed with an administrative

hearing on a CTA application may be violative of constitutional

due process. CFTC v. British American Commodity Options Corp.,

422 F.Supp. 662—footnote 6 to Appendix (S.D.N Y. 1976).

* British American filed its application on December 29, 1976,

utilizing its financial statements for the month ended Novem-

ber 30, 1976. Both the District Court and the Circuit Court

recognized that there were conflicting staff interpretations in De-

cember 1976 as to the proper method of computing net capital,

which were not resolved until December 21, 1976, the date of Judge

Knapp’s opinion.

request for a preliminary injunction to put Lloyd, Carr

out of business based on this theory was rejected by a

federal court, CFTC v. Lloyd, Carr & Co., et al. (77-371

T D.C. Mass.), an Administrative Law Judge of the CFTC

has filed a recommended decision holding that this is a

legal and proper basis to deny Lloyd, Carr’s FCM appli-

cation, to revoke its registration as a CTA and to impose

fines in excess of $125,000. The CFTC’s licensing scheme

and enforcement thereof violates both 5 U.S.C. §558(c)

and Pan Atlantic Steamship Corp. v. Atlantic Coastline

Railroad Co. et al., 353 U.S. 436 (1957). The CFTC’s

theory has also been approved by another Administrative

Law Judge with respect to British American.”

The Second Circuit’s holding on this issue is that since

these petitioners did not promptly file their FCM reg-

istration applications they are not in a position to com-

plain is not only contrary to the record but completely

avoids the important constitutional questions involved.”

Even more significant was the failure of the Circuit

Court to consider the rights of thousands of employees

who filed associated persons (“AP”) applications prior to

January 17, 1977 which are still not processed.” Consistent

with their prior public releases the CFTC has taken the

1° As of the date hereof the Commission has not rendered its

decision in either of these administrative proceedings.

11The regulations published on November 24, 1976, contain a

CFTC statement that it would take up to 60 days to process ap-

plications. January 17, 1977 is less than 60 days from Novem-

ber 24, 1976.

12 At the conclusion of oral argument the panel requested a

written report from the CFTC as to the status of the registration

applications. The CFTC refused to comment on the status of the

individual AP applications. If the writ is granted petitioners

intend to move for permission to file this letter as a supplemental

appendix, if not included as part of the record.

position that so long as such persons are not yet reg-

istered as APs, they cannot legally perform their jobs.

As a condition precedent to processing these AP applica-

tions the CFTC has been requiring an affidavit that any

such person has not been employed by a commodity option

dealer since January 17, 1977. In short, these persons

have been deprived of the right to earn a livelihood with-

out any hearing in direct contravention of the most ele-

mental due process. Yick Wo v. Hopkins, 118 U.S. 356,

369, 370 (1886); Hornsby v. Allen, 326 F.2d 605 (5th Cir.

1964) cited with approval in Goldberg v. Kelly, 397 U.S.

254 (1970). This has created utter chaos in the industry

and in its recent press releases the CFTC acknowledges

that there are thousands of unprocessed individual AP

applications. Many of these applications were filed over

6 months ago and involve individuals with impeccable

credentials.

The licensing scheme also poses a major threat to the

ultimate survival of specialty dealers since they cannot

obtain new employees. A competent individual cannot be

expected to go without work for six months to a year

waiting for the CFTC to process his application. This

scheme also discourages the entry of new companies, espe-

cially those which are not engaged in another line of busi-

ness.

IV. Anti-Trust Considerations

7 U.S.C. $19, reprinted in Appendix F hereto, is a unique

statute in that Congress has categorically directed the

CFTC to take into consideration the public interests to

be protected by the anti-trust laws and endeavor to take

** An employee of a securities broker-dealer or commodity fu-

tures dealer can continue to sell stocks, bonds, and futures contracts

until his application is accepted.

the least anti-competitive means of achieving the objec-

tives of the Act in issuing any regulation. Both the Dis-

trict Court and the Second Circuit found that many as-

pects of the regulations, including double segregation, were

anti-competitive. The District Court ruled that so long .

as the agency stated that it had considered the anti-trust

problems, the regulations, no matter how anti-competitive,

complied with the statute. The Second Circuit never dis-

cussed this issue.

It is respectfully submitted that this “reading” contra-

dicts not only the underlying legislative history (1974

U.S. Code Cong. Adm. News pp. 5847 and 5863) bui sets

a dangerous precedent for the federal bureaucracy be-

cause for all practical purposes it permits any agency to

disregard with impugnity a specific Congressional man-

date to foster competition.

In contrast to the instant case, in the absence of a

specific Congressional mandate to foster competition, an-

other circuit court has not hesitated to declare unlawful

and set aside agency actions which do not give effect to

the federal anti-trust laws. Pillai v. C.A.B., 485 F.2d 1018

(D.C. Cir. 1973); Overseas Media Corp. v. McNamara, 385

F.2d 308 (D.C. Cir. 1967); and Hecht v. Pro-Football, Inc.,

444 F.2d 931 (D.C. Cir. 1971), cert. denied, 404 U.S. 1047,

92 S. Ct. 701, 30 L.Ed.2d 736. The fact that the CFTC

deems it in the public interest to eliminate all existing

specialty dealers, either immediately throngh double segre-

gation or slowly with its licensing scheme or discrim-

inatory disclosure requirements and net capital computa-

tions, and replace them with the 5 or 6 major securities

and commodities broker-dealers or specialty dealers arbi-

trarily selected by them is not consistent with the purposes

of the Act.

V. Procedural Claims

It is respectfully submitted that in view of the scope,

nature and material impact of the regulations on parties

who were previously regulated by the CFTC, a fair read-

ing of the entire record, wholly apart from the defen-

dants’ self-serving corclusions which were taken at face

value, would have led to a contrary result in the Circuit

Court. Citizens To Preserve Overton Park vy. Volpe, 401

U.S. 402 (1971). The record clearly indicates, as found

by Judge Knapp, that these regulations were rushed

through. Moreover, the record clearly shows that the

procedures and tactics adopted by the defendants were

designed at every stage to minimize any meaningful partic-

ipation of the regulated parties in the rule making process

in contravention of 5 U.S.C. §553 and 7 U.S.C. §6e(b).

It is respectfully submitted that United States v. Florida

East Coast Ry. Co. (supra) is factually inapposite™ and

actually supports petitioners. If this decision is allowed

to stand, federal agencies will be free to deny regulated

parties the right to meaningful participation in the reg-

ulatory process.

However, of even greater importance is the rationale

that so long as a federal regulatory agency makes a state-

ment, irrespective of its truth or falsity or relationship

to the rules being adopted, justifying emergency effective-

ness of a rule or regulation the courts and the regulated

parties are foreclosed from questioning the legality of

notice under 5 U.S.C. §553 and 5 U.S.C. §706(2)(D).

14In that case the I.C.C. conducted extensive hearings where

witnesses were examined, asked for detailed information from the

parties to be regulated and then furnished comments to all parties.

The issue was whether the agency was required to hold additional

hearings. Moreover, the I.C.C. was not subject to a specific statute

such as 7 U.S.C. §6e(b).

Sections 32.8 and 32.9, the so-called anti-fraud rules, are

identical to the anti-fraud rule published on July 24, 1975,

which have always been applicable to the petitioners and

all other members of the industry and their employees.

CFTC v. J.S. Love & Associates Options, Ltd., 422 F.Supp.

652 (S.D.N.Y. 1976). A fortiori the alleged necessity to

promptly afford the public protection from fraud, under

these facts, clearly does not constitute “for good cause

found and published with the rule” within the meaning of

5 U.S.C. §553(d)(3). Secondly, although the competitors

of London commodity option dealers participated and in

fact were responsible for substantially all of this series of

new regulations, public participation by the parties to be

directly regulated and customers who have a substantial

interest was denied. In view of the nature, scope, and

arbitrary time limits, some of them announced after No-

vember 24, 1976, imposed by the CFTC petitioners as well

as thousands of individuals were materially prejudiced.

It is incumbent upon the judiciary to carefully analyze,

where appropriate, an agency’s justification for waiving

the notice requirements required by the Administrative

Procedures Act. Otherwise, for all intents and purposes

the notice provisions of 5 U.S.C. §553 and the whole con-

cept of participation in the regulatory process by the

parties to be regulated become absolutely meaningless.

It is respectfully submitted that the District Court’s

rulings, and in particular the Circuit Court’s holding with

respect to double segregation, are contrary to the proper

tests for granting an injunction as recently set forth in

Doran v. Salem Inn, Inc., 422 U.S. 922 (1975) and the

prior holdings of the Second Circuit as recently set forth

in Sonesta Int'l. Hotels Corp. v. Wellington Associates,

483 F.2d 247 (2nd Cir. 1973). Double segregation con-

cededly will put the petitioners as well as substantially

all of the members of this industry out of business. There

has been no showing that the failure of existing dealers

to double segregate has cost the investing public one

penny during the pendency of this litigation. The only

survivors and beneficiaries of this series of regulations

will be the two companies who have been arbitrarily

granted limited exemptions by the CFTC and a very

limited number of major securities and commodities broker-

dealers who will dominate this industry.

Furthermore, the Second Circuit’s denial of a prelim-

inary injunction by summary judgment is contrary to the

holding of the Seventh Circuit in Progress Development

Corp. v. Mitchell, (supra). The practical effect of the

Second Circuit’s ruling is to transform a request for a

preliminary injunction into a trial on the merits, thus

destroying the whole purpose of a preliminary hearing

to determine whether to maintain the status quo. Ac-

cordingly, the Supreme Court should clarify this conflict

between the Circuit Courts.

CONCLUSION

Based on the foregoing the undersigned on behalf of

the petitioners respectfully requests that certiorari be

granted.

Respectfully submitted,

Charles J. Hecht

Attorney for Petitioners

60 East 42nd Street

Suite 1760

New York, New York 10017

(212) 490-3232

Of Counsel:

Haic CostTirKyan

SUPPLEMENT

Total cost of option to customer $2,250.00

Premium transmitted immediately to London

as payment to the writer of the option 1,550.00

Gross commission of British American before

expenses 700.00

Commissions payable to executing brokers and

sales employee(s) 236.00

Gross profit on transaction prior to allocation

of indirect expenses: 464.00

Indirect expenses:

Telephone $126.92 APPENDIX

Rent 6.16

Indirect sales expenses 32.47

Back office salaries and com-

puter expenses 20.11

Legal and accounting 35.10

Officer salaries 2.28

Research department 11.20

Mise. 14.10

Total indirect expenses 248.34

Pre-tax profit 215.66

Provision for taxes 133.00

Net after-tax profit on transaction 82.66

Appendix A

(Memorandum and Order)

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF NEW YORK

76 Civ. 5124

BRITISH AMERICAN COMMODITY OPTIONS CORP.

and LLOYD, CARR & CO.,

—against—

WILLIAM T. BAGLEY, Chairman of the COMMODITY FUTURES TRAD-

ING COMMISSION: JOHN V. RAINBOLT III, Vice Chairman of the

COMMODITY FUTURES TRADING COMMISSION: READ P. DUNN,

GARY SEEVERS and ROBERT L. MARTIN, Commissioners of the COM-

MODITY FUTURES TRADING COMMISSION,

Plaintiff's,

Defendants.

76 Civ. 2250

NATIONAL ASSOCIATION OF COMMODITY OPTION DEALERS, a non-

profit association, BRISTOL OPTIONS INC., CHARTERED SYSTEMS

CORPORATION, BRITISH AMERICAN COMMODITY OPTIONS COR-

PORATION, CLEARY TRADING COMPANY, INC., FIRST NEW YORK

COMMODITY OPTIONS, LTD., FIRST WESTERN COMMODITY OP-

TIONS, INC. OF LOS ANGELES, WILLISTON CORPORATION, LLOYD,

CARR AND COMPANY and INTERNATIONAL COMMODITY OPTIONS,

LTD.,

Plaintiff's,

—against—

THE COMMODITY FUTURES TRADING COMMISSION, WILLIAM T.

BAGLEY, Chairman COMMODITY FUTURES TRADING COMMISSION,

JOHN B. RAINBOLT, II, Vice Chairman COMMODITY FUTURES

TRADING COMMISSION, GARY SEEVERS, Commissioner COMMODITY

FUTURES TRADING OOMMISSION, READ P. DUNN, Commissioner

COMMODITY FUTURES TRADING COMMISSION and ROBERT L.

MARTIN, Commissioner COMMODITY FUTURES TRADING COMMIS.

SION,

Defendants.

Appendia A

Kwapp, D.J.

Plaintiffs British American Commodity Options Corpo-

ration, Lloyd, Carr & Company, and the National Associa-

tion of Commodity Option Dealers, et al.,1 seek both in-

junctive and declaratory relief to restrain the defendants,

Commissioners of the Commodity Futures Trading Com-

mission (hereinafter “the Commission”), from enforcing

regulations concerning commodity option transactions pub-

lished in the Federal Register on November 24, 1976 of

which part went into effect on December 9, part is to go

into effect on December 27, and the balance is to go into

effect on January 17, 1977. 41 Fed. Reg. 51808. Plaintiffs

have moved for a preliminary injunction, and defendants

have cross-moved for summary judgment. For the reasons

which follow, we in part grant and in part deny defendants’

motion for summary judgment; and we grant plaintiffs’

motion for a preliminary injunction with respect to the

portion of the regulations which is to take effect on De-

cember 27, 1976, and otherwise deny such motion.

The jurisdiction of this court, which the defendants have

not contested, is premised on 5 U.S.C. §701 et seq., 7 U.S.C.

§3, 28 U.S.C. §1331, 28 U.S.C. $1337, 28 U.S.C. §2201 and

§2202.

The plaintiffs are dealers in “options” in certain com-

modities trading on certain exchanges in London, England.

? The National Association of Commodity Option Dealers, et al.

filed its complaint in the District Court for the District of Colum-

bia, and the case was assigned to Judge Rebinson. 76 Civ. 2250.

Upon hearing that the issues had already been presented to this

court and might be decided here first, they consented to a change

of venue. They then appeared and argued at the hearing on the

instant motions held in this court on December 10, 1976. Judge

Robinson granted a change of venue to this court on December 14,

1976. Plaintiffs then moved to consolidate their complaint with

that of plaintiffs British American and Lloyd, Carr. We hereby

grant that motion.

Appendiz A

That is to say they sell their U.S. customers options to

buy futures contracts traded on those exchanges. They

mount a wide variety of attacks upon the rules and regula-

tions of the Commission. We find only one of these to have

merit, and the major part of this opinion will be devoted

to explaining our difficulty with that regulation. Thereafter

we shall briefly deal with plaintiffs’ other criticisms. The

regulation as to which we find the complaint to have merit

is the one, effective December 27, 1976, which requires

plaintiffs to segregate 90% of the price their customers

pay them for the options. In view of the circumstance that

the nature of plaintiffs’ business—in which they act as

agents for London principals—requires them to immedi-

ately transfer to London about 75% of such purchase price,

we find this segregation requirement to be a hardship

which—as we shall develop—the Commission does not seem

to have adequately justified.

Facts

On October 23, 1974 the Congress enacted the Com-

modities Futures Trading Commission Act of 1974 (herein-

after “the 1974 Act”). 88 Stat. 1389. Th. Act in effect

constituted a series of amendments to the Commodity Ex-

change Act, which had initially been enacted in 1936. The

1974 Act created the Commission as an independent fed-

eral regulatory agency, and referred to it certain regulatory

functions previously within the jurisdiction of the Depart-

ment of Agriculture. The Act further vested the Commis-

sion with additional authority.

As enacted in 1936, the Commodity Exchange Act set up

methods of regulating trade in contracts of sale for future

delivery of certain commodities (“futures”). That Act also

prohibited trading in “options” with respect to the com-

Appendia A

modities regulated.? The 1936 Act covered only specifically

designated commodities.’ The 1974 Act expanded the def-

inition of commodities subject to regulation to include vir-

tually all previously unregulated commodities, by bringing

within its scope all “goods and articles . . . and all services

rights and interests in which contracts for future delivery

are presently or in the future dealt in...” *

With respect to the commodities previously regulated,

the 1974 Act continued the absolute prohibition on trading

in options.’ However, with respect to trading in options

in the newly covered commodities, the 1974 Act authorized

the Commission either to extend the absolute prohibition

to such trading or to subject it to regulation.‘

2A commodity option gives the purchaser the right, during a

specified period of time, to buy (“call”) and/or sell (“put”) at a

set price a specific futures contract or, in the case of an option

on an actual commodity, a specific quantity of that commodity. In

the case of so-called “London options” of the type offered by plain-

tiffs here, the option relates to futures contracts on commodities

traded on the London commodity markets.

* Commodities Exchange Act §2(a), 7 U.S.C. §2. The number

of commodities regulated increased from time to time after 1936.

See the Advisory Committee Report to the Commission, July 6,

1976 (“the Advisory Committee Report”), p. 96, n. 37.

‘Commodity Futures Trading Commission Act of 1974, §201,

Section 2(a) of the Commodities Exchange Act as amended, 7

U.S.C. §2 (Supp. V, 1975).

®’ Coramodity Futures Trading Commission Act of 1974, §402,

Comme lities Exchange Act as amended, §4c(a), 7 U.S.C. §6e(a)

(Supp. ¥, 1975).

* Commodity Futures Trading Commission Act of 1974, §402,

Commodities Exchange Act as amended, §4ce(b), 7 U.S.C. §6e(b)

(Supp. V, 1975). The 1974 Act also gave the Commission exclusive

jurisdiction to regulate these. Commodities Exchange Act §2(a)

(1), 7 U.S.C. §2 (Supp. V, 1975).

Appendix A

The plaintiffs in this action deal in “options” in previ-

ously unregulated commodities’ and challenge the regula-

tions the Commission has imposed upon them pursuant to

the 1974 Act.

So far as here relevant, the pertinent statute provides:

“No person shall offer to enter into, enter into, or

confirm the execution of, any transaction subject to

the provisions of subsectidi (a) of this section in-

volving any commodity regulated under this Act, but

not specifically set forth in section 2(a) of this Act,

prior to the enactment of the Commodity Futures

Trading Commission Act of 1974, which is of the

character of, or is commonly known to the trade as,

an ‘option’, ‘privilege’, ‘indemnity’, ‘bid’, ‘offer’, ‘put’,

‘call’, ‘advance guaranty’, or ‘decline guaranty’, con-

trary to any rule, regulation, or order of the Commis-

sion prohibiting any such transaction or allowing any

such transaction under such terms and conditions as

the Commission shall prescribe within cne vear after

the effective date of the Commodity Futures Trading

Commission Act of 1974 unless the Commission deter-

mines and notifies the Sen: te Committee on Agricul-

ture and Forestry and the House Committee on Agri-

culture that it is unable to prescribe such terms and

conditions within such period of time: Provic»), That

any such order, rule, or regulation may be made only

after notice and opportunity for hearing: And pro-

vided further, That the Commission may set different

terms and conditions for different markets.” *

7 Plaintiffs British Am rican and Lloyd, Carr act as agents for

others who write optior . »n two London exchanges.

® The 1974 Act §402, the Commodities Exchange Act as amended

§4c(b), 7 U.S.C. §6e(b) (Supp. V, 1975).

Appendia A

Legislative History of the 1974 Act

The Congressional decision to expand the commodities

subject to regulation arose out of the financial failure of

at least one company, Goldstein, Samuelson, Inc. which

sold options in the unregulated commodities for which no

underlying futures contract had been purchased so that

customers who tried to exercise their options were de-

frauded. Congressional hearings focused on this scandal.’

This led the House of Representatives to first consider

a bill which expanded the commodities subject to regula-

tion and extended the prohibition on trading in options

to all these commodities. HR. 11955.’ However, follow-

* Plaintiffs state the Congress focused on only one large failure

which defrauded customers, whereas defendants maintain it fo-

cused on several. Defendants brief on summary judgment, p. 7.

Congressional hearings documented that Golstein Samuelson,

Inc. had started business with a thin capital base, and had con-

ducted business by collecting premiums from unsophisticated in-

vestors and using these to pay off the customers who exercised their

options. The company had obtained few futures contracts to

“eover” or “hedge” their obligations because futures contracts are

relatively more expensive than the premiums received, and as

noted before, the company had little capital above and beyond the

premiums received. The company expected to make a profit or

the theory few customers would exercise their options because they

would have incorrectly guessed market movements, and therefore

enough money would be left from customer premiums to repay the

few who exercised. Ultimately, when too many customers tried to

exercise their options, the company defaulted on its obligations,

went bankrupt and many customers were deprived of the benefit

of their bargain. Hearings on H.R. 11955 before the House Com-

mittee on Agriculture, 93d Cong., 2d Sess., ser. 93-TT, at 181-182,

194-196 (1974); see also Hearings on S. 2485 S. 2578, S. 2837

and H.R. 13113 before the Senate Committee on Agriculture and

Forestry, 93d Cong., 2d Sess. pt. 1, at 224-225 pt. 3, at 682-683,

824-25, 830-835 (1974).

1° House Committee on Agriculture Report on the Commodities

Futures Trading Commission Act of 1974, H.R. Rep. No. 975, 93d

Cong., 2d Sess. 36-37 (1974).

Appendia A

ing hearings at which several witnesses testified that op-

tions trading might be economically useful and that regu-

lations could be devised to protect option purchases," the

House introduced a new bill, H.R. 13113, which author-

ized the Commission to decide whether to ban or regulate

option trading in the newly regulated commodities. This

section of H.R. 13113 is substantially the same as that

finally enacted into law and reads as follows:

“No person shall offer to enter into, enter into, or con-

firm the execution of, any transaction subject to the

provisions of subsection (a) of this section involving

any commodity regulated under this Act, but not

specifically set forth in section 2(a)(1) of this Act,

prior to the enactment of the ‘Commodity Futures

Trading Commission Act of 1974’, which is of the

character of, or is commonly known to the trade as,

an ‘option’ ‘privilege’, ‘indemnity’, ‘bid’, ‘offer’, ‘put’,

‘call’, ‘advance guaranty’, or ‘decline guaranty’, con-

trary to any rule, regulation,-or order of the Com-

mission prohibiting any such transaction or allowing

any such transaction under such terms and conditions

as the Commission may prescribe: Provided, That

any such order, rule, or regulation may be made only

after notice and opportunity for hearing: And pro-

vided further, That the Commission may set different

terms and conditions for different markets.”

™ Hearings on H.R. 11955 before the House Committee on Agri-

culture, 93d Cong., 2d Sess. at 37, 40-41, 176-180, 199, 251, 329

(1974) see Advisory Committee Report, p. 98.

Appendia A

The House report on this portion of the bill states:

“Options Trading (Section 402)

The discretionary authority granted the CFTC to

regulate or ban trading in options in commodities...

is not to be exercised by the Commission to approve

any transaction of the character of, or commonly

known as an ‘option’, .. . if the option or transaction

named does not guarantee the purchase of the futures

contract in fulfillment of the option, should the pur-

chaser seek to exercise the option. The Committee

intends the Commission act as expeditiously as pos-

sible to prohibit such transaction.” ™

The Senate amended this portion of the House bill to

require the Commission to prescribe regulations governing

options within one year after the effective date of the bill

and to clarify the jurisdiction of the Commission relative

to that of other regulatory agencies. The Senate other-

wise retained the language of the House bill. The Senate

Committee report on which the Senate had acted stated:

“The Committee intends that options not be traded

except on organized exchanges and in conformity with

the rules and regulations of the Commission.” ™

The Conference Committee report does not contain any

reference to any limitation on the scope of the Commis-

sion’s discretion. The Conference substitute embodied the

House provision as amended by the Senate with a further

amendment which according to the Conference report pro-

vided that:

12 H.R. Rep. No. 975, 93d Cong., 2d Sess. 31 (1974).

188. Rep. No. 1131, 93d Cong., 2d Sess. 36 (1974).

Appendia A

“The period for issuing regulations governing such

options trading may be extended if the Commission

determines, and notifies the Senate Committee on

Agriculture and Forestry and the House Committee

on Agriculture, that it will be unable to promulgate

such regulations within the one-year period.” ™“

Both Houses adopted the Conference substitute which be-

came §4c(b) of the Commodities Exchange Act. Under

this statutory provision, option dealers in commodities

not regulated prior to 1974 could continue to do business

in their accustomed manner until the Commission—by

% H.R. Rep. No. 1383, 93d Cong., 2d Sess. 40 (1974). The full

text of the Joint Explanatory Statement of the Committee of Con-

ference on this portion of the bill states:

“(16) Options trading.

The House bill continues the ban now contained in section

4c of the Act on trading in options (privileges, indemnities,

bids, offers, puts, calls, advance guaranties, and decline guar-

anties) in the now-regulated commodities, but permits trading

in options in all other commodities if not done contrary to

any rule, regulation, or order of the Commission prohibiting

any such transaction or allowing any such transaction under

such terms and conditions as the Commission may prescribe.

The Commission could promulgate such an order, rule, or

regulation only after notice and opportunity for hearing. The

Commission may set different terms and conditions for differ-

ent markets.

The Senate amendment retains the House provision, but

provides that the Commission is to prescribe the regulations

governing such options trading within one year after the ef-

fective date of the bill.

The Conference substitute adopts the Senate provision with

an amendment providing that the period for issuing regula-

tions governing such options trading may be extended if the

Commission determines, and notifies the Senate Committee on

Agriculture and Forestry and the House Committee on Agri-

culture, that it will be unable to promulgate such regulations

within the one-year period.”

10a

Appendiz A

regulations promulgated after notice and opportunity for

hearing—either required them to do otherwise or pro-

hibited trading in options.

History of this Rulemaking

On April 25, 1975 the Commission published its first

set of proposed rules pursuant to §4c(b). 40 Fed. Reg.

18187. Termed “antifraud rules”, these were designed to

prevent deceptive practices in connection with the sale of

commodity options. The Commission adopted these in

amended form on June 24, 1975 to take effect immediately

40 Fed. Reg. 26504.**

On October 22, 1975 the Commission published notice

that it was “considering the adoption of further rules to

regulate—or perhaps forbid—transactions in commodity

options”. 40 Fed. Reg. 49360. The regulations ultimately

adopted by the Commission pursuant to this rulemaking

are those challenged in the instant action. The basis and

purpose for considering rules additional to the antifraud

rules was stated to be:

“Commodity-option offerings appear to have prolifer-

ated, and many of these offerings appear questionable

since in most cases investors are not given adequate

assurance that the issuers of the options will be able

to perform their obligation under the option contracts

when and if required to do so.” 40 Fed. Reg. 49360.

*® The Commission brought an injunctive action to restrain vio-

lations of these sections. Commodities Futures Trading Commis-

sion v. J.S. Love & Associates Options, Ltd., (S.D.N.Y. 1976)

720,198, CCH Comm. Fut. L. Rptr. Judge Bonsal denied injunc-

tive relief because there was no likelihood the practices he found

to be deceptive would be repeated. See also Commodities Futures

Trading Commission v. British American Commodity Options

Corp. (8.D.N.Y. 1976) 920,224 CCH Comm. Fat. L. Rptr., J.

Gagliardi.

lla

Appendia A

The broad alternatives under consideration included: pro-

hibiting all commodity option transactions, restricting

these to contract markets, allowing only those sold in

accordance with a “business plan” approved by the Com-

mission and/or allowing only those sold by persons reg-

istered with the Commission. The Commission assigned

to an Advisory Committee the responsibility of making

recommendations to the Commission. 40 Fed. Reg. 49360.

This Advisory Committee was composed of fourteen per-

sons. Two were Commissioners of the five-member Com-

modity Futures Trading Commission.** The remaining

twelve were mainly from law firms and private industry.”

The Commission invited the public te submit comments

to both it and the Advisory Commitiee on these broad

alternatives and specific enumerated issues. The concept

of segregation was not specifically mentioned at this time.

The Commission further stated that pending receipt of

the Advisory Committee’s recommendatic as and digestion

of public comments it might adopt temporary rules with-

out further public notice should it find these urgently

necessary “to protect the public”.

After considering the comments submitted in response

to its October 22, 1975 notice, the Commission published

proposed rules for comment on February 20, 1976. 41

Fed. Reg. 7774." It proposed that all commodity option

16 John Rainbolt, the Vice-Chairman of the Commission, was

Chairman of the Advisory Committee and William Bagley, the

Chairman of the Commission, was an ex-officio member of the

Advisory Committee.

11 For biographies of the members of this Advisory Committee,

see the Advisory Committee Report, p. 174f.

18 The Commission had not yet received the report of its Ad-

visory Committee.

12a

Appendiz A

dealers be required: to register with the Commussion as

commodity option dealers, to file a disclosure statement

with the Commission and inform each customer such was

publicly available at the Commission, and to meet minimum

financial standards (that assets exceed liabilities and that

“net working capital” exceed $100,000 excluding the pre-

miums received from customers).'* Commodity option deal-

ers who failed to meet these requirements would be pro-

hibited from trading in options.

However, the Commission stated it would entertain re-

quests for exemptions from the net working capital re-

quirement from those commodity option dealers “who

act solely on an agency basis for other dealers who issue

or assume full financial responsibility for the commodity

option transaction” since it recognized that the require-

ment “may be inappropriate” for these agent dealers.”

The Commission further stated it had decided not to

require commodity option dealers to segregate funds re-

ceived from customers until the option was exercised or

expired “because of inherent difficulties of ascertaining

which dealer should segregate (i.e., the problem of double

segregation)”.** Nonetheless, the Commission stated it

was “particularly interested in receiving comments as to

19 See 41 Fed. Reg. at 7778 for further definition of the exclu-

sions and inclusions to the net working capital requirement.

2° Plaintiffs are agents for others who write options on two Lon-

don exchanges. Plaintiffs have claimed that their principals are

required to assume the full financial responsibility for the option

transaction.

21By this statement the Commission may have meant that in

those situations where an option dealer acts as an agent, whose only

obligation is to transfer customer premiums to the option writer

it might not be appropriate to require such agent to “segregate”

the premium he was already obliged to transfer to another.

13a

Appendia A

whether such a requirement could and should be im-

posed”.**

In addition the Commission stated that after it received

the Advisory Committee report and comments to these

proposed rules:

“the Commission will determine whether it will require

additional time to study the recommendations and

comments in order to evaluate the extent to which

they.should be included as part of a permanent reg-

ulatory program. If the Commission believes that

such additional time is required, the proposed rules

may be adopted as interim and temporary rules only.”

41 Fed. Reg. 7774.

After publication of these proposed rules, the Commis-

sion received many comments, and on March 8, 1976 it

held a public hearing. On July 6, 1976 it received the

report of its Advisory Committee.

The Chairman of the Advisory Committee, who also

was the Vice-Chairman of the Commission, prefaced this

report with the question “Commodity Options in the U.S.:

What test?’ He stated “The statute, itself, is silent.”

However, he noted that the Act includes standards guiding

Commission regulation of futures and that:

“Tt has been suggested that the Cummission apply the

same test for options that it applies for futures con-

tracts, t.e., that ‘they not be contrary to the public

22 The Commission also requested comments as to whether it

should require option dealers to deliver disclosure statements to

prospective customers in advance of any option transaction, and

whether it should permit commodity options to be traded on con-

tract exchanges and ultimately restrict option trading to such

exchanges.

14a

Appendia A

interest ... I suggest the Commission require that

proponents of option trading should be prepared to

meet requirements and procedures similar to those

required by the Commission for futures trading on

contract markets which are designated by the Com-

mission.” **

The Advisory Committee followed the Chairman’s sug-

gestions and recommended to the Commission that options

dealers should be subject to the same basic requirements

that are imposed on futures merchants. One of the re-

quirements it therefore recommended was that options

dealers segregate funds received from customers.”

The Advisory Committee did not indicate whether or

not it had taken into account the circumstance that options

dealers—who act as agents and have to forward to their

principles funds received from customers—would find this

segregation requirement more burdensome than futures

dealers who act as principals for their own account. They

did, however, state the recommendations were tentative

and preliminary since the area of commodity option trading

was complex and the data on which the recommendations

were based was inadequate.**

23 Advisory Committee Report, p. xv-xvi. This report was trans-

mitted to the Committee on July 6, 1975 and published as a special

supplement to the CCH Commodity Futures Law Reporter on July

15, 1976.

*4 Id., pp. 18, 30, 47-48. The Advisory Committee recommended

requiring dealers to segregate that portion of the customer’s funds

which represented the premium paid for the option right, leaving

the dealer free to use that portion representing his costs and com-

mission. It did not suggest specific percentages.

26 Td., pp. vi, xiii

“While it is not, and was not intended to be the ‘ultimate’ study

on the subject (which must of necessity await more definitive

15a

Appendia A

On October 8, 1976 the Commission published a modified

version of its February proposals which it termed “pro-

posed interim regulations” to take effect November 22,

1976. 41 Fed. Reg. 44560. It also invited comment as to

whether these should be modified prior to their adoption.

The reason given for adopting these as “interim regula-

tions” was that the Commission planned in 90 days to put

into effect a second stage of regulations. The Commission

described this proposed second stage as:

“comprehensive regulations for a limited, rigidly-

controlled three-year (or shorter) test program that

ultimately will require commodity options to be pur-

chased and sold on or through the facilities of Com-

mission-designated boards of trade. . .”

The Commission further stated:

“The test program will be designed to determine the

nature and extent of the impact of commodity option

trading on the underlying futures and cash markets,

the economic utility of commodity option trading and

the capability of the exchanges to conduct adequate

market surveillance and to assure orderly markets

... the test program will enable the Commission to

obtain sufficient data on which to have a permanent

regulatory program concerning commodity options

or, if necessary, to determine to prohibit trading in

data), its: undertaking was suggested as an initial step in

dealing with the issues posed by §4c(b) of the Commodities

Exchange Act.” Id., p. vi...

“There are limits to the use of the Advisory Committee forum

itself, especially in an area as complex as commodity option

trading, where the lack of needed data regarding the subject

hampered the Advisory Committee’s inquiries.” IJd., p. xiii.

16a

Appendia A

commodity options in the United States.” 41 Fed. Reg.

at 44560.

Among the interim regulations proposed to take effect

in November, 1976 was §32.6 which provided for segrega-

tion.* In proposing this regulation the Commission recog-

nized that it might cause hardship, especially to those who

—like plaintiffs—act as agents for members of London ex-

changes. Thus the Commission observed:

“The Commission is aware that proposed § 32.6 may,

in certain cases, require ‘double segregation.’ For ex-

ample, in the case of the sale cf London options, a

person receiving the funds from an option customer

in the United States as payment for the option may

not remit those funds to London in order to obtain

or maintain the option position with a London broker.

The Commission believes that the proposed segrega-

tion requirements are essential customer protection

to be afforded commodity option customers in the

United States. The Commission recognizes, however,

that its proposed segregation requirements may im-

pose a financial hardship on some affected persons.”

41 Fed. Reg. 44562."

6 Thi posed regulation provided that the option dealers who

were required to register must segregate 100% of the funds re-

ceived from customers. 41 Fed. Reg. at 44567.

oF these Commission rules would require agent option

oamee as plaintiffs to keep the customer's funds segregated

in the United States, thereby requiring them, in turn, to obtain

additional funds to remit to London in order to obtain the option

ition.

dition, we note that plaintiffs have claimed that their prin-

A... turn, are required by the London exchanges of which they

are members to segregate all customer premiums so that the agents’

customers will be protected. The Commission has disputed this

claim, citing the Advisory Committee Report, pp. 41-42, 130-139.

17a

Appendiz A

The Commission accordingly requested comments and sug-

gestions for viable alternatives.

After receiving several comments, the Commission pub-

lished revised rules on November 24, 1976, which are those

now under challenge. 41 Fed. Reg. 51808. Insofar as con-

cerns segregation, the Commission revised the amount to

be segregated, reducing it from 100% of the funds received

from customers to 90% of those funds.* Despite this re-

duction the Commission reiterated its recognition that

adoption of this segregation requirement might impose

hardship, “particularly with respect to the sale of London

options”, but simply stated that no acceptable alternative

susceptible of immediate implementation had been sug-

gested. Thus the Commission observed:

“Several commentators have indicated that letters of

credit, bonding requirements, and other forms of finan-

cial guarantees could be used as alternatives to segre-

gation. While the Commission believes that these

suggestions are on the whole constructive, and while

the Commission would urge continued efforts by com-

mentators to suggest suitable alternatives to the seg-

regation requirement, specific proposed alternatives

have not yet been submitted which would be capable

of being effectuated to coincide with the adoption of

the interim rules. Accordingly, the Commission has

determined to include segregation requirements in the

interim rules as adopted... .” 41 Fed. Reg. 51812.

The Commission did indicate that it would consider ap-

plications for exemption from the segregation requirement,

** See the memorandum of the National Association of Com-

modity Option Dealers in support of the complaint, Exhibit ITI,

for excerpts of the minutes of the Commission’s meeting at which

the reduction from 100% to 90% was approved.

18a

Appendia A

but made quite clear that it would subject such applications

to rigorous scrutiny, and that exemptions would be granted

only if “the Commisison finds, in its discretion, that it

would not be contrary to the public interest to grant such

exemption.” 41 Fed. Reg. at 51812.

Discussion

With respect to the regulation requiring segregation, the

essential facts are that as first proposed in February, 1976,

the rules contained no such requirement. The Commission

then specifically noted that such a requirement might well

be inappropriate for some option dealers. In July, the

Advisory Committee specifically noted that the underlying

statute provided no standards to guide its determination.

Indicating that it would look for guidance to the standards

and methods used in regulating dealers in futures contracts

it recommended that option dealers be required to segre-

gate, There is nothing in the Advisory Committee report

to suggest that it had considered whether such a require-

ment—which had originally been devised to apply to dealers

in futures contracts who normally act as principals—could

be appropriately applied to option dealers who, like plain-

tiffs, act only as agents.

Acting on the Advisory Committee’s report and other

comments, the Commission in October for the first time

proposed a rule requiring segregation, specifically calling

attention to the hardship involved and calling for the sug-

gestion of alternatives. Having rejected all alternatives

which were suggested on the ground they were not sus-

ceptible of immediate implementation, the Commission in

November announced adoption of its interim segregation

rule—to take effect December 27, 1976.

19a

Appendia A

The only reason stated for this admittedly harsh action

was the need for speed to protect the public. The Commis-

sion does not cite, and we cannot find, any reason or fact

which had come to its attention since the rules were pro-

posed in February without any provision for segregation

which would seem to justify this need for haste.** Such

haste seems especially unjustified in view of the admittedly

harsh consequences of the rule and the Commission’s con-

tinuing search for alternatives. In the circumstances, we

must conclude that plaintiffs have a reasonable likelihood

of success in establishing that defendants acted arbitrarily

and capriciously in imposing segregation requirements—

at least as applicable to option dealers, who, like plaintiffs,

act only as agents. See e.g., National Nutritional Foods

Association v. Weinberger (2d Cir. 1975) 512 F.2d 688, 701,

cert. den. 423 U.S. 827.

Although it has not been claimed that the authority

granted the Commission pursuant to §4c(b) constituted an

2° Although the Commission appears to justify such haste by ad-

verting to the Congressional directive in §4c(b) that it promul-

gate rules with respect to options within one year, we note that

the Conference Committee amendment which was embodied in the

final version of the bill provided an exception to this requirement

if the Commission determines and notifies both Houses of Congress

“that it is unable to prescribe such terms and conditions within

such period.” We further note that the Commission did promul-

gate one set of rules concerning option transactions, the antifraud

rules, within the one year period. In addition, on October 8, 1976

the Commission stated: at 41 Fed. Reg. 44560, n.5:

“Section 4c(b) also provides that, if possible, rules were to be

adopted within one year after the effective date of the section.

However, the Commission advised Congress, in accordance

with the provisions of section 4c(b), that it would be unable

to meet the one-year time period ending April 21, 1976, within

which to have comprehensive commodity option regulations

in effect and that additional time would be required to carry

out the Congressional mandate contained in section 4c(b).”

See 41 FR 16885 (April 21, 1976)

ae Se a ee *

20a

Appendia A

invalid delegation of authority because of the Congress’

failure to provide any standards to guide the Commission,

we do note that the Commission’s Vice-Chairman has spe-

cifically observed that the statute is silent on the matter

of standards. See p. 13a, supra. Whether or not such fail-

ure to provide standards could be said to invalidate this

portion of the legislation (compare Panama Refining Com-

pany v. Ryan (1936) 292 U.S. 388 and Wright, Beyond Dis-

cretionary Justice, 81 Yale L.J. 575 (1972) with Davis, A

New Approach to Delegation, 36 U. Chi. L.R. 713 (1969)),

such failure should at least be deemed to impose on the

Commission the obligation of taking particular pains to

ensure that its rulemaking will not be arbitrary and capri-

cious. See Davis op. cit., supra.

Therefore, with respect to the regulation requiring seg-

regation, it is our conclusion of fact that plaintiffs are

threatened with irreparable injury in that, being required

by the necessities of their business to forward to their prin-

cipals in London the premiums for options they sell to their

customers (representing at least 75% of the funds received

from customers), they could not long remain in business

if required to segregate in the United States an amount

equal to 90% of such funds.** It is our conclusion of law

that—for the reasons above outlined—plaintiffs have a

reasonable likelihood of success on the merits of their at-

tack on the segregation requirement. We further conclude,

in light of the wide panoply of regulations already and

about to be in effect, that the public interest will not be

adversely affected by preliminarily enjoining these segre-

gation requirements.

2% The Commission’s suggestion that this could be accomplished

by bank financing is not persuasive.

21a

Appendia A

In addition to the above discussed claim with respect

to segregation, plaintiffs British American and Lloyd, Carr

put forth a wide variety of contentions as follows:

1. defendants violated the Administrative Procedure Act

(A.P.A.) 5 U.S.C. §553 by failing to give an oppor-

tunity for meaningful public comment on the rules

published November 24, 1976 and by publishing a

portion of these rules to be effective in less than 30

days without good cause.

2. defendants’ actions are unsupported by substantial '

evidence in violation of 5 U.S.C. §706(E).

3. the minimum financial and the disclosure require-

ments adopted are arbitrary and capricious in viola-

tion of 5 U.S.C. §706(2) (A).

4. the defendants acted in excess of their statutory juris-

diction under the Commodities Exchange Act §15

7 U.S.C. $19 in that the regulations promulgated are

anti-competitive.

5. the defendants acted “without due process as guar-

anteed by the Fifth and the Fourteenth Amendments

to the Constitution since the defendants are not au-

thorized to put the plaintiffs out of business through

the imposition of rules”.*®

We find none of these to have merit.

With respect to the claim that defendants violated the

Administrative Procedure Act, 5 U.S.C. $553 by promul-

gating rules November 24, 1976 which allegedly were sub-

stantially different from earlier rules without having given

the public the opportunity for meaningful comment there-

3° Amended Complaint {8b, p. 4.

22a

Appendia A

on, we find the Commission provided adequate notice of

each of the provisions now contained in its rules and ade-

quate opportunity to comment thereon. To meet this sec-

tion of the A.P.A., which requires the agency to give notice

of proposed rules and to give interested persons an oppor-

tunity to participate in the rulemaking, it is sufficient that

the proposed rules to which comments are addressed give

reasonable notice of the subjects and issues. The Admin-

istrative Procedure Act does not require that the rules

adopted be identical to those proposed. California Citt-

zens Band Association v. United States (9th Cir. 1967)

375 F.2d 43.

With respect to the claimed violation of §553(d)—in that

a portion of the Commission’s rules published November

24, 1975 were to take effect less than 30 days thereafter,

we find the Commission adequately stated and published

good cause for its action." Thus, it met the terms of the

exception to the requirement of 30-day publication found

in subsection (3) of §553(d).”

31 The Commission stated :

“The Commission finds that the public interest requires that

the foregoing rules be adopted without any further delay inas-

much as the public has been without the protection of a com-

prehensive regulatory program in an area which historically

has been fraught with abuses. Moreover, there has been ample

notice and publie participation in this rule-making proceeding

and affected persons have had adequate notice and opportunity

to comment on the subject of these rules and the issues in-

volved in their consideration, as well as the terms of the rules

themselves substantially as adopted. Furthermore, affected

persons have had an adequate opportunity, through prior

notices, to take the necessary steps to be in full compliance

with the rules by the effective dates thereof.” 41 Fed. Reg.

at 51817. See also 41 Fed. Reg. at 51810, column 1.

%2In fact, most of the changes relieved prior proposed restric-

tions, thus meeting the terms of another exception to 30-day pub-

lication, that stated in subsection (1) of §553(d).

23a

Appendia A

Plaintiffs’ claim that defendants’ actions are unsup-

ported by substantial evidence cannot be considered. 5

U.S.C. §706(E) makes it clear this standard of review is

applicable only to rulemakings pursuant to 5 U.S.C. §556

and §557. The rulemaking here involved was not required

to be conducted pursuant to those sections of the Admin-

istrative Procedure Act since the Commodities Exchange

Act §4c(b) does not require these hearings to be “on the

record.” Section 4c(b) of the Act requires only that regu-

lations concerning options be made “after notice and op-

portunity for hearing.”

One of the attacks upon the minimum financial require-

ments as arbitrary and capricious rests on the theory that

the segregation requirements will unduly deplete plain-

tiffs’ assets and thus prevent them from meeting the mini-

mum financial requirements. That argument has been dis-

posed of by our ruling with respect to segregation. At oral

argument we were persuaded that the other arguments

against the minimum financial requirements were grounded

upon a misunderstanding of the Commission’s regulations.

The claim that the disclosure requirements are arbitrary

and capricious also rests on plaintiffs’ erroneous reading

of the regulations. We accept the Commission’s represen-

tation at oral argument that plaintiffs are not required to

specify the exact results of currency fluctuations and other

items not susceptible of knowledge at the time of a sale,

but are required only to list and explain such uncertainties.

In connection with price items, the requirement is to ex-

plain the elements and the method of calculation. The dis-

closure requirements otherwise appear to us to not be

arbitrary or discriminatory.

The claim that the Commission failed to adopt the least

anti-competitive means and that this violates the Commod-

24a

Appendiz A

ities Exchange Act §15, 7 U.S.C. 419 (Supp. V, 1975) raises

no question for us to review. The section cited does not

require the Commission to adopt the least anti-competitive

means, but only requires it to

“take into consideration the public interest to be pro-

tected by the antitrust laws and endeavor to take the

least anticompetitive means of achieving the objec-

tives of this Act, as well as the policies and purposes

of this Act, in issuing any order or adopting any Com-

mission rule or regulation . . .” (emphasis supplied).

Plaintiffs have shown us no reason to challenge the Com-

mission’s statement that it did consider the anti-competi-

tive impact of various alternatives. 41 Fed. Reg. 51809.

In view of our decision with respect to the segregation

requirements, the claim that defendants acted without due

process “since the defendants are not authorized to put

the plaintiffs out of business through the imposition of

rules” can be dismissed since plaintiffs are not in danger

of being put out of business.”

In addition to the claims made by the original plaintiffs

the National Association of Commodity Option Dealers has

claimed that the requirement that option dealers register

as “futures commission merchants” is in excess of statu-

tory authority because the Commodities Exchange Act spe-

cifically defines futures commission merchants as “individ-

uals... engaged in... [the] sale of any commodity for

future delivery on or subject to the rules of a contract

33 In addition, we note that §4c(b) of the Commodities Exchange

Act does authorize the defendants to prohibit trading in options

provided the defendants act by rule or order after notice and

opportunity for hearing.

25a

Appendia A

market. ...”** The Commission has itself answered this

in the Federal Register notice of November 24, 1976:

“One commentator suggested that the Commission’s

determination to make it unlawful for persons to ac-

cept money and other funds from option customers

unless registered as futures commission merchants was,

in effect, an amendment of the Act’s definition of a

futures commission merchant. The Commission dis-

agrees. Persons who come within the definition of

futures commission merchant in section 2(a)(1) of the

Act are required to register as such thereunder. The

Commission’s adoption of the interim rules in no way

alters that obligation and in no way alters the defini-

tion of futures commission merchant contained in the

Act. Rather, as the Commission stated at the time of

its October 8, 1976 proposal, the Commission has de-

termined, pursuant to its plenary power to regulate

commodity option transactions, to entrust options ac-

tivities only to persons who meet the basic financial

and other requirements of futures commission mer-

chants and associated persons of specified futures com-

mission merchants under the provisions of the Act and

the regulations promulgated thereunder.”

We think this adequately disposes of the argument.

** Section 2(a)(1) of the Commodities Exchange Act, 7 U.S.C.

§2. We note that the Commission has previously taken the position

that other provisions of the Commodities Exchange Act which use

the language “commodities for future delivery on oi subjett™to

the rules of a contract market”, for example §4b, “may not apply

to option transactions since these transactions are not made ‘on

or subject to the rules of any contract market.’” 40 Fed. Reg.

18188 (April 25, 1975).

26a

Conclusion

On the basis of the foregoing we deny plaintiffs’ motion

for a preliminary injunction except as it applies to that

portion of its rules requiring segregation (432.6). With

respect to that requirement, the defendants are prelim-

inarily enjoined from enforcing it against any plaintiff who

is in the business of selling options as an agent.

The defendants’ motion for summary judgment is denied

with respect to the said requirement of segregation, and is

otherwise granted.

Settle order on notice.

Dated: New York, New York

December 21, 1976.

Wuitman Kwapp,

U.S.D.J.

27a

Appendix B

(Order and Judgment)

UNITED STATES DISTRICT COURT

For tHe SoutrHern District or New York

[CAPTION OMITTED]

This cause came on for hearing on December 10, 1976,

on plaintiffs’ motion for an order preliminarily enjoining

the defendants, who are the members of the Commodity

Futures Trading Commission, from implementing or en-

forcing regulations relating to commodity option transac-

tions published in the Federal Register on November 24,

1976, and on the defendants’ cross-motion for summary

judgment, pursuant to Rule 56 of the Federal Rules of

Civil Procedure. The Court having heard the argument of

counsel and having considered the affidavits, exhibits and

leg2l memoranda in support of the motions and in oppo-

sition thereto and all other papers heretofore filed in the

ease, and due deliberation having been had thereon, it is

hereby

Orperep, that the defendants, their officers, agents, ser-

vants, employees and attorneys, and those persons in active

concert or participation with them who receive actual notice

of this order, be and they hereby are preliminarily en-

joined, during the pendency of this action, from enforcing

the segregation requirements contained in Section 32.6 of

said regulations against any plaintiff who is in the busi-

ness of selling options as an agent for a principal; and it is

further

28a

Appendiz B

Orperzp that defendants’ motion for summary judgment

is in all respects granted except with respect to the segre-

gation requirements set forth in Section 32.6 of said regu-

lations, and, there being no just reason for delay, judgment

is hereby directed to be entered in favor of the defendants

on all issues other than the enforcement of Section 32.6.

Dated: January 3, 1977

New York, N.Y.

Wuirman Kwapp,

U.S8.D.J.

29a

Appendix C

(Opinion of Court of Appeals)

UNITED STATES COURT OF APPEALS

For tur Seconp Crircuir

Nos. 863, 864, 865—September Term, 1976.

(Argued February 9, 1977 Decided April 4, 1977.)

Docket Nos. 77-6010, 77-6011, 77-6019

Sonal

Berrish American Commopiry Options Corp. and

Luoyp, Carr & Co.,

Plaintiff s-A ppellants-

Cross Appellees,

—against—

Wu T. Bacuzy, Chairman of the Commodity Futures

Trading Commission, et al.,

Defendants-A ppellees-

Cross Appellants.

NationaL Association oF Commopity Options

Dezaxers, et al.,

Plaintiff s-Appellants-

Cross Appellees,

—against—

Tas Commopiry Futures Trapinc Commission, et al.,

Defendants-A ppellees-

Cross Appellants.

30a

Appendia C

Before:

Fernserc, Gurrers and MESKILL,

Circuit Judges.

Appeal from order of the United States District Court

for the Southern District of New York, Whitman Knapp,

J., granting a preliminary injunction against regulation

requiring dealers to segregate customer funds, but in other

respects granting summary judgment against challenges

to regulations of commodity options trading.

Affirmed in part and reversed in part.

Cuaries J. Hecut, New York, N. Y. (Haig Cos-

tikyan, David Greene, Martin Kaplan, Gus-

rae, Greene & Kaplan, on the brief), for

Plaintiffs-Appellants-Cross Appellees Brit-

ish American Commodity Options Corpora-

tion and Lloyd, Carr & Co.

Lzonarp R. Goipstern, College Park, Maryland,

for Plaintiffs - Appellants -Cross Appellees

National Association of Commodity Options

Dealers, Bristol Options, Inc., Chartered

Systems Corporation, Cleary Trading Com-

pany, Inc., First New York Commodity Op-

tions, Inc. of Los Angeles, Williston Cor-

poration and International Commodity Op-

tions, Ltd.

Freperic T. Sprvpet, Washington, D.C. (Rich-

ard E. Nathan, Acting General Counsel,

Commodity Futures Trading Commission,

and Virginia F'. Crisman, on the brief), for

3la

Appendiz C

Defendants-A ppellees-Cross Appellants The

Commodity Futures Trading Commission,

William T. Bagley, John V. Rainbolt II,

Gary Seevers, Read P. Dumn and Robert L.

Martin.

—~-o->—

Fernsere, Circuit Judge:

Nine commodity options dealers and the National Asso-

ciation of Commodity Option Dealers (NASCOD) in this

consolidated action challenge new rules that regulate the

commodity options industry. The Commodity Futures

Trading Commission (Commission) promulgated the rules

under authority granted in 1974 by the Commodity Fu-

tures Trading Commission Act, Pub. L. 93-463, 88 Stat.

1389, 7 U.S.C. $4 1-22 (Supp. V, 1975). Plaintiffs claim

that the regulatory scheme violates various requirements

of the Administrative Procedure Act, 5 U.S.C. §§551

et seq. (1970), and the United States Constitution. Prior

to the effective dates of the new rules, plaintiffs brought

suit in the federal courts’ for declartory relief, and moved

for a preliminary injunction against implementation of

the rules. With the certified record of the informal rule

making proceeding before him, Judge Whitman Knapp of

? Plaintiffs British American Commodity Options Corp. and

Lloyd, Carr & Co. sued in the United States District Court for

the Southern District of New York on November 15, 1976, No. 76

Civ. 5124. NASCOD and other plaintiffs filed initially in the

United States Court for the District of Columbia, No. 76 Civ. 2250.

Upon learning that the same issues had been presented in New

York, the plaintiffs in the D.C. action appeared in New York on

December 10, 1976 and argued the motions that led to the instant

appeal. The D.C. district court granted a change of venue four

days later, and Judge Knapp in New York granted a motion to

consolidate the two actions.

32a

Appendia C

the United States District Cour for the Southern District

of New York enjoined the regulation that required segre-

gation of customers’ funds, but otherwise denied plaintiffs’

motion and granted summary judgment for the Commis-

sion. We reverse the injunction against the segregation

rule, and in other respects affirm the judgment of the dis-

trict court.

The Commodity Options Industry

The commodities business operates as a marketplace

of contracts. The contracts traded are for the purchase,

or sale, of specific amounts of a commodity* either that

have already been produced, or that will be produced in

the future and delivered by a specific date. This latter

group of contracts are known as “commodity futures.” *

2? The Commodity Futures Trading Commission Act, 7 U.S.C. § 2

(Supp. V, 1975), defines “commodity” as

wheat, cotton, rice, corn, oats, barley, rye, flax-seed, grain

sorghums, mill feeds, butter, eggs, Solanum tuberosum (Irish

potatoes) wool, wool tops, fats and oils (including lard, tallow,

cottonseed oil, peanut oil, soybean oil and all other fats and

oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean

meal, livestock, livestock products, and frozen concentrated

orange juice, and all other goods and articles, except onions

as provided in section 13-1 of this title, and all services, rights,

and interests in which contracts for future delivery are pres-

ently or in the future dealt in... .

*For general descriptions of the market’s operation, see R.

Teweles, C. Harlow & H. Stone, The Commodity Futures Game

(1974) ; Horn, Commodities, in The Stock Market Handbook 307-

15 (F. Zarb & G. Kerekes eds. 1970). See also Johnson, The

Perimeters of Regulatory Jurisdiction under the Commodity Fu-

tures Trading Commission Act, 25 Drake L. Rev. 61 (1975), which

describes the shift in emphasis of commodity regulation from farm

interests to investor protection, and Smith, Commodity Futures

Trading, 25 Drake L. Rev. 1 (1975).

33a

Appendia C

A “commodity option” is a contractual right to buy, or sell,

a commodity or commodity future by some specific date at

a specified, fixed price, known as the “striking price.”‘ A

contract entitling its owner to purchase the commodity is

known as a “call,” and a contract entitling its owner to sell

is called a “put.” In the plainest case, an option is cre-

ated, or “written,” by the owner of a commodity or com-

modity futures contract, who commits himself to sell his

goods or contract. But an option can also be written by

anyone else willing to take the chance that he will be able

to cover his obligation in the futures market, if the option

purchaser decides to exercise the option. Such an option

is described as “naked.”

The plaintiff firms in this case deal in “London options,”

which are options on futures contracts for certain com-

modities that are traded in London, England, on either the

London Metals Exchange (LME) or several other ex-

changes whose transactions are cleared through the Inter-

national Commodity Clearing House (ICCH). The plain-

tiff firms sell London options in the United States and,

according to plaintiffs British American Commodity Op-

tions Corp. and Lloyd, Carr & Co., operate as follows:

Plaintiffs actively solicit customers through direct mail

and telephone contacts, as well as by newspaper and tele-

vision advertising. When a customer orders the purchase

of a commodity option, the dealer furnishes him with a

notice giving the details of the transaction including the

nature of the underlying futures contract, the price the

writer charges for the option, known as the “premium,”

the dealer’s commission, and the market on which the trade

‘ For a fuller description of commodity futures options and their

uses as investment tools, see S. Kroll & I. Shisko, The Commodity

Futures Market Guide 258-68 (1973).

34a

Appendia C

will be executed. The customer may or may not have paid

for the option when this notice is sent; only payment of

the purchase price to the dealer commits the customer to

buying the option. The price quoted in the notice is firm,

however, for five days, which means that the dealer as-

sumes the risk of a price increase during that period.

Once the dealer receives cash payment, he executes the

trade through a “clearing member” of one of the English

exchanges. The dealer then immediately forwards the pre-

mium amount to the clearing member, who pays the option

writer. At the same time, the dealer sends another notice

to the customer giving final details of the transaction.°

To profit from this purchase, the customer must exer-

cise the option before it expires. Exercising the option

means buying the underlying futures contract. Since the

customer normally has no interest in actually receiving the

commodity on the delivery date, the clearing member then

sells a futures contract short for the customer. The dif-

ference between the price at which the option is exercised

plus the cost of purchasing the option (premium and com-

mission) and the price at which the futures contract is

sold is the customer’s profit. If, however, the market price

for the futures contract has dropped below the striking

price, the customer allows the option to expire, in which

case he loses his entire investment.

Market Regulation

Intimations of difficulties in the commodity options

market came to the attention of Congress in the early

1970's; existing laws had not worked well in preventing

5 See Long, Commodity Options—Revisited, 25 Drake L. Rev. 75,

111-128 (1975), for an excellent description of the London options

market and the sale of London options in the United States.

35a

Appendiz C

abuses in the options industry.‘ Options were an especially

hospitable environment for abuse because a naked option

could be created out of nothing, if the writer was willing

to run the risk of not covering his obligation by acquiring

an offsetting position in the futures market. Thus, entry

into the business of options required little capital. In addi-

tion, options bear lower price tags than the futures con-

tracts underlying them, so the options market may be

peculiarly attractive to individual investors of relatively

modest means and with a propensity for taking risks.

Before 1974, regulation of trading in commodity futures

and options derived mainly from the Commodity Exchange

Act, 7 U.S.C. §§1-17b (1970).7 That Act empowered the

Commodity Exchange Authority of the Department of

Agriculture to administer certain limited regulations on

trading in a number of agricultural commodities,’ and

completely banned options on them. 7 U.S.C. § 6e¢ (1970).

On October 23, 1974, Congress enacted the Commodity

Futures Trading Commission Act, supra, which created

the Commission as an independent regulatory agency with

* H.R. Rep. No. 93-975, 93d Cong., 2d Sess. 36-53 (1974).

7 Attempts to invoke the securities laws in this context have met

with only mixed success. Compare Continental Marketing Corp. v.

SEC, 387 F.2d 466 (10th Cir. 1967), with Glazer v. National Com-

modity Research and Statistical Service, Inc., No. 74-1861 (7th Cir..

filed Jan. 7, 1977). See generally 1 A. Bromberg, Securities Law:

Fraud 82.241-69 (1975) ; Long, supra note 5.

®7 U.S.C. §2 (1970) provided, in pertinent part:

The word “commodity” shall mean wheat, cotton, rice, corn,

oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter,

eggs, onions, Solanum tuberosum (Irish potatoes), wool, wool

tops, fats and oils (including lard, tallow, cottonseed oil, pea-

nut oil, soybean oil and all other fats and oils), cottonseed

meal, cottonseed, peanuts, soybeans, soybean meal, livestock,

livestock products, and frozen concentrated orange juice.

36a

Appendia C

plenary rulemaking power. The Act also substantially

broadened the field of regulation, to include virtually all

“goods and articles,” see note 2, supra.’ The Commission

was given

exclusive jurisdiction with respect to accounts, agree-

ments (including any transaction which is of the

character of, or is commonly known to the trade as,

an “option”, “privilege”, “indemnity”, “bid”, “offer”,

“put”, “call”, “advance guaranty”, or “decline guar-

anty”), and transactions involving contracts of sale

of a commodity for future delivery.

7 U.S.C. §2 (Supp. V, 1975).

The new Act perpetuated the old Act’s absolute ban on

option trading for the commodities listed in the old Act,

7 U.S.C. §6c(a) (Supp. V, 1975), but permitted other

options to be written and to trade in compliance with rules

promulgated by the Commission. 7 U.S.C. 4 6ce(b) (Supp.

V, 1975). The Act authorized the Commission “to make

and promulgate such rules and regulations as, in the judg-

ment of the Commission, are reasonably necessary to

effectuate any of the provisions or to accomplish any of

the purposes of this chapter.” 7 U.S.C. § 12a(5) (Supp. V,

1975).

se April 25, 1975, soon after the Commission came into

official existence, it published for public comment a pro-

* Onions were excepted, in accordance with Pub. L. 85-839, 72

Stat. 1013 (1958), which prohibited all trading in onion futures.

Congress took this action after onion producers reportec that price

variations in the futures market had been adversely affecting the

cash price of onions. See S. Rep. No. 1631, 85th Cong., 2d Sess.

(1958) ; H.R.Rep. 1036, 85th Cong., Ist Sess. (1957), reprinted in

[1958] U.S. Cong. Code & Admin. News 4210-4215.

37a

Appendia C

posed anti-fraud rule, 40 Fed. Reg. 18187 (1975), that

broadly proscribed fraudulent and deceptive practices and

the making of false statements in connection with com-

modity options transactions. The anti-fraud rule became

effective June 24, 1975. The Commission exp!ained that its

swift action was necessary because the Act’s grant of ex-

elusive jurisdiction to the Commission had left the public

without regulatory protection.

In October 1975, the Commission announced that it was

considering rules to regulate or prohibit all options trading.

The Commission also announced the appointment of an

Advisory Committee on the Definition and Regulation of

Market Instruments” to study the options situation and

recommend suitable regulations. The public notice solicited

suggestions of temporary rules to be adopted, and offered

for consideration a number of alternative approaches:

prohibition of all community options transactions: restrict-

ing options trading to established contract markets; allow-

ing trading only of options written as part of a Commis-

sion-approved “business plan”; prohibition of “naked”

options; or registration by the Commission of dealers who

comply with certain Commission fiduciary requirements.

40 Fed. Reg. 49360-62 (1975). The Commission did receive

some comments from the public, although apparently none

from any plaintiff.

On February 20, 1976, the Commission published its

proposed temporary rules to govern commodity options

transactions. 41 Fed. Reg. 7774 (1976). The proposal

1° The Committee was composed of seventeen members. It in-

cluded various industry leaders, exchange officials, economists, at-

torneys, the Illinois securities commissioner, a farmer-rancher, a

consumer representative, and two members of the Commission, one

of whom served as the Committce’s chairman.

38a

Appendia C

called for all options dealers, among other things, to

of working capital, to keep certain records, and to disclose

to options customers that certain information about the

options dealer could be obtained from the Commission.

Notably absent from the proposal was any requirement

that the dealer set aside, or “segregate,” any portion of the

customer’s cash payment until the option is sold or

exercised. The Commission did, however, indicate that it

was “particularly interested” in comments on the wisdom

of such a requirement. 41 Fed. Reg. 7776 (1976).

At an oral hearing in March 1976, the Commission

received the views of various witnesses, including counsel

for British American. The Commission also received

written comments, some supporting segregation, and in

July 1976, the Advisory Committee transmitted its report,

which also supported segregation.

On October 8, 1976, the Commission published proposed

interim regulations, intended to become effective on No-

vember 22. Written comments from the public were invited

on or before November 8. British American submitted com-

ments and requested oral hearings, which the Commission

did not provide. The Commission adopted the regulations,

substantially in the form it had proposed, on schedule and

gave public notice on November 24, 41 Fed. Reg. 51808

(1976), but delayed effectiveness for 15 days, except that

the segregation requirement was delayed 30 days.

The new rules forbid an option dealer to do business

after January 17, 1977 unless he is registered as a “futures

commission merchant” (FCM) under the Act. 17 C.F.R.

§ 32.3 (1976). To be registered, a dealer has to comply with

a new minimum capital requirement, 17 C.F.R. §1.17

(1976), that the dealer maintain adjusted working capital in

39a

Appendia C

excess of the greater of $50,000 or a formula figure, one of

whose components is five percent of the dealer’s aggregate

indebtedness. The new disclosure rule, 17 O.F.R. § 32.5

(1976), requires the option customer to be furnished a

“summary disclosure statement” prior to the commodity

option transaction. The statement must contain, among

other things, a brief description of the “total quantity and

quality” of the commodity under the option, its duration,

the elements comprising its purchase price, the method by

which the striking price is established, the amount of the

commission to be charged, a statement that the price rise

(for a call) or price fall (for a put) must exceed the

premium amount plus costs in order for the option customer

to make money, and a clear explanation of the possible

effects of currency fluctuations on options executed through

foreign facilities. Section 32.6 of the new regulations

requires an FCM to segregate 90 percent of the payment

received from the customer in a United States bank account

until expiration or exercise of the option. Also, the rules

require an FCM to keep pertinent records of each trans-

action. 17 O.F.R. § 32.7 (1976).

The new rules announced on November 24 differed in

several respects from the October 8 version. In addition

to postponing the effective dates, as indicated above, the

new rules relaxed the earlier proposed requirement that

the summary disclosure statement be furnished no less

than 24 hours before the transaction. The Commission

changed this requirement to allow the statement to be

furnished merely “prior” to the transaction, because of

public comments that the proposed rule was unrealistic in

light of the volatile nature of the commodities markets. In

addition, the new rules change the requirement that

particularized price information be disclosed before rather

40a

Appendia C

than after the transaction. And the amount to be segre-

gated was reduced from 100 percent to 90 percent so that

an FCM could immediately get funds for commissions,

salaries, and administrative expenses. See 41 Fed. Reg.

51811-13 (1976).

As indicated above, plaintiffs’ efforts in the district court

to enjoin operation of the new rules were unsuccessful,

except for the segregation requirement. Except for that

portion of the order, plaintiffs urge us to reverse the judg-

ment of the district court. The Commission cross-appeals

and seeks reversal of the injunction against the segregation

requirement.

Procedural Claims

Plaintiffs claim that the regulations were adopted in

violation of the rulemaking notice provision of the Adminis-

trative Procedure Act, 5 U.S.C. 4 553 (1970). The regula-

tory scheme was published in final form only 15 days before

_ most of it became effective. Plaintiffs argue that this wait-

ing period was impermissibly short under § 553(d), which

provides that “the required publication or service of a

substantive rule shall be made not less than 30 days before

its effective date, except ... (3) as otherwise provided by

the agency for good cause found and published with the

rule.” The statutory hiatus, plaintiffs assert, allows inter-

ested parties a chance to participate meaningfully in the

rulemaking process, and enables the agency to educate it-

self properly. Where, as here, both the system of rules

and the agency itself are newly created, this rationale is

particularly compelling. Moreover, two plaintiffs charge

the Commission with purposeful evasion of the procedural

requirement, They claim that the November 24 publication

4la

Appendia C

came as a direct response to their November 15 filing of a

complaint against the rules in the federal district court,

and that since the Commission had indicated that oral hear-

ings on the October 8 proposal would be held sometime in

December, the Commission thus actively deterred the firms

f.om participating in the rulemaking process during Octo-

ber and early November. Finally, plaintiffs appear to

claim that in any event some sort of oral hearing before

the Commission after October 8 was required before the

new rules could be issued.

Fairly characterized, however, the Commission’s proce-

dures adequately complied with statutory requirements and

did no substantial injustice to the plaintiffs. The Commis-

sion first published notice of its plan to promulgate regula-

tions in October 1975. The first specific proposal was re-

leased on February 20, 1976, and in March oral hearings

were held. After consideration of the views there expressed

and of the report of the Advisory Committee, the Commis-

sion on October 8, 1976 announced its revised proposal,

which was finally adopted in substantially the form then

proposed. Notwithstanding the language of 4402 of the

new Act, 7 U.S.C. §6c(b), which provides that “any...

order, rule, or regulation may be made only after notice

and opportunity for hearing,” no oral hearing was re-

quired after October 8. United States v. Florida East Coast

Ry. Co., 410 U.S. 224 (1973). Nor did the Commission an-

nounce that there would be one, as some of the plaintiffs

imply. With respect to the time period, plaintiffs appear to

argue that the changes between the October 1976 proposal

and the final rules announced on November 24 were snf-

ficient to trigger a new 30-day wait. We doubt this, see

Chrysler Corp. v. Department of Transportation, 515 F.2d

1053, 1061 (6th Cir. 1975); California Citizens Band As-

42a

Appendia C

sociation v. Umited States, 375 F.2d 43, 48-49 (9th Cir.

1967), and we note that all the changes appear to have

relaxed the requirements for the plaintiff firms. But in any

event, the Commission was not required to delay effective-

ness another 30 days if “good cause” for acceleration was

“found and published with the rule.” The November 24

announcement declared the following:

In order to assure full and fair consideration of the

various proposals that have been made over the many

months in which option regulations have been con-

sidered, it has not been possible to implement appropri-

ate regulations before now. That consideration having

now been completed, however, the Commission finds

that the public interest requires that the foregoing

rules be adopted without any further delay inasmuch

as the public has been without the protection of a

comprehensive regulatory program in an area which

historically has been braught with abuses. Moreover,

there has been ample notice and public participation

in this rule-making proceeding and affected persons

have had adequate notice and opportunity to comment

on the subject of these rules and the issues involved in

their consideration, as well as the terms of the rules

themselves substantially as adopted. Furthermore, af-

fected persons have had an adequate opportunity,

through prior notices, to take the necessary steps to be

in full compliance with the rules by the effective dates

thereof.

We agree with Judge Knapp that this statement was

adeqnate to satisfy the requirement of § 553, especially

since plaintiffs have made no showing of prejudice to them

from the 15-day acceleration of the effective date of the

43a

Appendia C

new rules. They had ample time both to participate in the

rulemaking process and to ready themselves to comply

with the rules whose effective date the Commission ac-

celerated. And the segregation requirement, about which

plaintiffs complain the most, was delayed for 30 days after

November 24.

Segregation

As already indicated, Judge Knapp granted a prelim-

inary injunction against the new segregation requirement.

17 C.F.R. § 32.6 (1976). That section requires that 90 per-

cent of the customer’s money be retained in an American

account until performance under the option contract is

complete. But the London exchanges, which allegedly

maintain their own systems of customer safeguards, must

simultaneously be sent that portion of the customer’s money

that represents the premium amount. Thus, the American

options dealer must himself have the funds to place a

major portion of the price of the option he sells in a

segregated account. British American estimates that this

“double segregation” burden will require it to raise several

million dollars in capital, which may be impossible for it.

Moreover, plaintiffs argue, such strangulation of the in-

dustry is manifestly unnecessary in light of the London

exchanges’ own system of financial safeguards.

The Commission was not unmindful of these considera-

tions. The October 8, 1976 notice took account of the

possibility of heavy capital demands on dealers in London

options, and invited suggestions of alternatives. But the

Commission stressed then, and repeated in the November 24

publication of the rules as adopted, that its primary pur-

pose was to protect customers’ money from the sort of

d4a

Appendia C

abuses that have plagued the field." The Commission

looked warily at safeguards allegedly implemented abroad,

noting that “assets [segregated in the United States] will

not be subject to the attachment or other laws or require-

ments of any other nation.” 41 Fed. Reg. 44564 (1976).

Evidence in the record raised serious questions about

whether the English safeguards would effectively protect

the American customer. At the Commission’s March 1976

oral hearing, counsel for British American in effect con-

ceded that the London guarantees do not run to options

customers in the United States. Moreover, stringent con-

trols on the use of customers’ money are particularly

sensible in an industry, such as commodity options trading,

that attracts some thinly capitalized firms. In the absence

of such protection, a need for capital might prod a dealer

into over-dependence on customers’ money to finance

general operations. In that event, if some difficulty should

arise in the chain of transactions needed to generate a profit

for the customer seeking to exercise his option, he might be

left without a readily available source for recoupment of

his investment. Thus, the very point plaintiffs raise to

challenge the wisdom of requiring domestic segregation—

their financial vulnerability—argues strongly for the re-

quirement. And the Commission has pointed out that

financially stable firms may be able to meet the capital

demands of segregation by borrowing, and using the

interest they can obtain on the segregated funds to defray

a good part of the cost of borrowing.

Judge Knapp noted that the scheme of regulations as

originally proposed in February 1976 had no segregation

11 See, e.g., SEC v. Continental Commodities C ion, 497

F.2d 516 (Sth Cir. 1974) ; SEC v. Univest, Inc., 405 F. Supp. 1057

(N.D. Ill. 1976). See also H.R. Rep. No 93-975, supra note 6.

45a

Appendia C

requirement, and he saw no reason for its hasty addition.

He concluded that the preliminary injunction would not

adversely affect the public interest, and that “plaintiffs

have a reasonable likelihood of success in establishing that

defendants acted arbitrarily and capriciously in imposing

segregation requirements.” * He looked to the prospect

that the plaintiff firms “could not long remain in business”

if required to segregate as one indication that the require-

ment might be unreasonable.

On the basis of the Commission’s justifications and the

record before us, we disagree with the district court that

the segregation requirement should be enjoined. The

Commission’s conclusion that in light of past abuses, the

public now needs this minimal protection carries great

weight. And in any event, the requirement is not unreason-

able even if it threatens to restrict participation in the

industry to soundly capialized firms."* Nor does it appear

that the Commission adopted the requirement with undue

haste. The Commission first publicly raised the possibility

of segregation in October 1975, although at that time no

regulations were put forward. The February 20, 1976

notice again broached the subject. 41 Fed. Reg. 7776.

Although the proposed rules published then did not call

for segregation, the Commission did request comments on

the idea, and in July 1976, the Advisory Committee publicly

recommended segregation. Furthermore, the February

1976 proposal had more stringent net capital requirements

8 We agree with Judge Knapp that the proper test to apply was

the arbitrary and capricious standard of 5 U.S.C. § 706 (2) (A).

Naitonal Nutritional Foods Association v. Weinberger, 512 F.2d

668, 700-01 (2d Cir.), cert. denied, 423 U.S. 827 (1975).

Indeed, the rulemaking power vested in the Commission by

Congress allows the possibility that the Commission might ban

options transactions altogether. 7 U.S.C. § 6¢(b) (Supp. V, 1975).

46a

Appendia C

and apparently compelled the dealer to maintain in the

United States assets sufficient to cover not only its

customers’ investments but also even the unrealized gains

on the customers’ options. 41 Fed. Reg. 7783-84 (1976).™

When in October 1976 the Commission’s new proposal

relaxed the net capital requirements, the segregation rule

that replaced it was by no means a complete surprise. The

Commission had, with the aid of public participation, been

considering it for almost a full year. Nor did the Commis- .

sion’s examination of the segregation rule cease with

publication of the October 8 proposal. That version

required 100 percent segregation, but the Commission

reduced that figure to 90 percent in the final rule.

We conclude, therefore, that the Commission’s decision

to impose a segregation requirement was a reasonable

exercise of its discretion in an effort to protect the public,

and that the Commission’s analysis of the problem and

alternative solutions was adequately deliberate. We hold

that the district judge erred in granting plaintiffs a pre-

liminary injunction against the segregation requirement.

Registration

Under 17 C.F.R. § 32.3 (1976), all commodity options

dealers must register with the Commission by January 17,

1977. Plaintiffs attack the requirement on several grounds:

14The February proposal required the dealer to maintain

$100,000 in net working capital. Moreover, the proposal required

computation of net working capital as of the close of each business

day, in accordance with a prescribed method designed to take into

account the exposure that a commodity option dealer might ex-

perience “should the market move against the dealer and in favor

of a purchaser.” See 41 Fed. Reg. 7778 (1976). This approach

was tailored to a market in which a dealer was allowed to both write

and sell options. By October, the Commission had decided

allowing dealers to write options. 41 Fed. Reg. 44560 (1976).

47a

Appendiz C

(1) the Commission’s position that it could not assure

applicants that their filings would be processed by the dead-

line unless filed by December 27 was unreasonable because

Judge Knapp only upheld the regulations on December 21;

(2) the regulation’s structure—requiring registration by

January 17, 1977 rather than filing—vests the Commission

with unbridled discretion to exclude any applicant from

the options business simply by not acting on the applica-

tion for registration ; (3) section 32.3 conflicts diametrically

with 17 C.F.R. $1.19 (1976): the former requires options

dealers to register as FCM’s, and the latter section forbids

FCM’s to “make, underwrite, issue, or otherwise assume

any financial responsibility for the fulfillment of, any

[option transaction ].”

Plaintiffs’ first two arguments are in essence that the

Commission acted high-handedly in proclaiming the Jan-

uary 17 deadline. Especially since the agency confronted

a previously unregulated field, plaintiffs stress, it should

have made conscientious efforts to avoid unnecessarily dis-

rupting the industry. We agree that the laudable intent to

protect the public cannot give regulators unbridled free-

dom to do as they wish. Viewing the Commission’s conduct

here as a whole, however, we do not believe that there was

substantial injustice or gratuitous disruption. Plaintiffs

did have reasonable advance notice that registration would

be required and could not rely on the possible success of

their lawsuit as an excuse for not being prepared to file.

Moreover, the Commission has not dragged its feet on the

applications filed. After oral argument, the Commission

advised us by letter that it had not yet acted on the filings

of only two of the plaintiff firms, both of which had filed

during January. Three other plaintiffs remain unregis-

tered, but they are the subjects of administrative proceed-

48a

Appendia C

ings brought by the Commission to determine whether

registration should be refused. Under the circumstances,

the attack on the registration requirement must fail.

Similarly, there is no merit to the argument that § 32.3

may conflict with §1.19 and thereby, in effect, preclude

plaintiffs from engaging in the commodity option business.

The American firms dealing in London options operate

solely as agents, a role the Commission has not deemed to

constitute an assumption of “financial responsibility”

barred by $1.19. British American and Lloyd, Carr urge

that the Commission “can always take the position that

since the retail London commodity options dealers are re-

sponsible for transmitting customer funds to and from

London they ‘otherwise assume financial responsibility, ” **

thereby violating 4 1.19. However, as long as the Commis-

sion construes its own regulations consistently, plaintiffs’

claim is devoid of merit. If the Commission acts incon-

sistently—and we do not assume or suggest that it will—

plaintiffs have shown that they know how to go to court

to protect their rights.

Disclosure

Implementation of the disclosure requirements in the

new regulations correlates with a decline in options sales

for plaintiffs. For example, British American tells us that

its gross options premiums per month dropped from

$2,238,748 in November 1976 to less than $1 million in

December. Net income from options simultaneously fell off

sharply. British American attributes this decline to the

Commission’s “severe” and “punitive” requirements which

seriously disadvantage options dealers in competition with

16 Brief of appellants British American and Lloyd, Carr at 40.

49a

Appendia C

dealers of futures contracts or stock options. They further

argue that it is unfair not to make the requirements also

applicable to traders only of futures since the customer

takes a greater risk in a futures transaction: A futures

customer may be subject to margin calls, whereas the com-

modity options customer, who pays the full premium in

cash, cannot be.

We do not doubt that full disclosure of commissions and

fees and a clear statement of what must happen before the

customer makes money from his option cool the public’s

ardor for options. But the Commission concluded that such

disclosure is an effective way to help the public make in-

formed investment decisions. We cannot say that this

judgment was arbitrary or irrational. Indeed, it seems

sensible; the very fact that the disclosures have so dras-

tically affected plaintiffs’ business supports the Commis-

sion’s position. As for the comparative leniency of dis-

closure requirements for futures and stock options," the

Commission was entitled to rely on the added supervision

of those markets,"’ and the extensive disclosures required

from the issuers of the securities that underly stock

options.

Minimum Financial Requirements

Plaintiffs also attack the minimum capital requirement

for FCM’s, 17 C.F.R. § 1.17 (1976), as arbitrary, capricious,

and unreasonable. Plaintiffs complain that the $50,000

16 Stock options trading. is regulated by the Securities and Ex-

change Commission, not by the Commodity Futures Trading Com-

mission.

11 For a summary of regulation of futures trading and commod-

ity futures exchange activities under the new Act, see Smith, supra,

note 3 at 33-44.

50a

Appendia C

minimum is arbitrarily pegged at five times the minimum

requirement for commodity futures dealers, even though

futures trading involves much greater sums of money than

options trading. Furthermore, plaintiffs argue, the defini-

tion of “aggregate indebtedness” in $1.17 pits the dealer’s

interest against that of his clients by requiring the dealer

“to take a 5% ‘haircut’ on customers’ equity.” By this

plaintiffs mean that as the value of a customer’s option

goes up (if that happens), the dealer’s indebtedness to the

customer is deemed to rise simultaneously so the dealer

must augment his working capital by 5 percent of the

increase.

With respect to the $50,000 minimum, the Commission

explained in its November 24 notice: “Based on its ex-

perience, . . . the Commission believes that the distinction

in working capital requirements between futures commis-

sion merchants who are engaged in options activity as

opposed to those who are not, is necessary to provide a

cushion against losses which are more likely to arise in

the commodity options area.” 41 Fed. Reg. 51813 (1976).

In support of its position, the Commission points out that a

FCM dealing only in futures contracts must reassess its

position on a daily basis in light of unrealized gains and

losses on its customers’ contracts. Also, industry self-

regulatory organizaiions, which monitor. futures dealers,

can detect early signs of a firm’s financial instability. We

cannot say that the Commission’s judgment was arbitrary.

Regarding the inclusion of customers’ equity as part of

aggregate indebtedness, there has been some confusion

among the parties as to precisely what the requirement is.

In affidavits filed with the district court on December 3,

1976, and with this court on January 13, 1977, counsel for

18 Brief of appellants British American and Lloyd, Carr at 44.

dla

Appendia C

British American indicated that the difficulty had arisen

from conflicting agency interpretations of the requirement.

On December 1, 1976, the Acting Branch Chief of the Com-

mission’s Eastern Regional Office wrote to Crown Colony

Options, Ltd., that the “haircut” was required by 4 1.17.

Yet on December 3 the Commission’s auditing staff began

applying a policy of not requiring the “haircuts” when the

FCM acts solely as an agent. And in this court the Com-

mission has again conceded that unrealized gains on

options contracts will not be treated as amounts payable to

customers for purposes of the net capital computation.

With the Commission’s position thus clarified, plaintiffs’

claim evaporates.

Other Claims

NASCOD argues that the record-keeping requirements in

§ 32.7 may be unnecessary, especially the requirement that

the FCM maintain a list of all prospective commodity

option customers to whom solicitations are directed. We

accept the Commission’s justification that

This provision imposes no greater burden than

placing a check mark next to the name and address of

the customer on the solicitation list utilized. Moreover,

the Commission believes that this information, as well

as its books and record-keeping requirements generally,

will assist in the Commission’s monitoring of the

activities of persons offering commodity option trans-

actions for compliance with the interim rules.

41 Fed. Reg. 51813 (1976).

Plaintiffs claim throughout that the district court erred

in granting summary judgment because issues of material

fact remained unresolved. In sum, we are told that

52a

Appendiaz C

“genuine material questions of fact were raised concerning

whether the Commission acted arbitrarily and capri-

ciously.” * But it is quite clear, as we have already held,

that the Commission’s actions were not arbitrary or

capricious. If plaintiffs’ contention is that the district

court was required to hear new evidence on the justification

for the regulations issued by the Commission, we do not

agree. See Citizens to Preserve Overton Park, Inc. v.

Volpe, 401 U.S. 402, 414-15 (1971). Plaintiffs have also

advanced other arguments, which we have considered and

found to be without merit. Accordingly, the judgment of

the district court is affirmed except for the grant of in-

junctive relief against the segregation requirement, and

as to that portion of the order we reverse.

19 Brief of appellants NASCOD, et al. at 10.

53a

Appendix D

(Order of Court of Appeals Dated June 8, 1977)

UNITED STATES COURT OF APPEALS

For tHe Seconp Crrecurr

Docket No. 77-6010

At a Stated Term of the United States Court of

Appeals, in and for the Second Circuit, held

at the United States Court House, in the

City of New York, on the sixth day of June,

one thousand nine hundred and seventy-

seven.

Present:

Hon. Wirrep Fernserc,

Hon. Murray I. Gurrer,

Hon. Tuomas J. Mesxr1,

Circuit Judges.

Brrrish AMERICAN Commopity Options Corp.,

& Lroyp, Carr & Co.,

Plaintiff s-Appellants-Appellees,

Wri T. Bactey, etc.,

Defendants-A ppellees-A ppellants.

54a

Appendia D

Nationa, Assn. or Commopiry Option DEALERS, ETC.,

Plaintiff s-Appellees,

Tue Commopitry Futures Trapinc CoMMISSION, ETC.,

Defendants-A ppellees-Appellants.

A petition for a rehearing having been filed herein by

counsel for the Bririsx American ComMopity Options

Corp., anp Luioyp, Carr & Co.

Upon consideration thereof, it is

Ordered that said petition be and hereby is denied.

/s/ A. Dante Fusaro

A. Daniel Fusaro,

Clerk

55a

Appendix E

(Order of Court of Appeals Dated June 14, 1977)

UNITED STATES COURT OF APPEALS

For tHe Seconp Crrcurr

At a Stated Term of the United States Court

of Appeals, in and for the Second Circuit,

held at the United States Court House, in

the City of New York, on the 14th day of

June, one thousand nine hundred and

seventy-seven.

Docket No. 77-6010

British AMERICAN CommMopity Options Corp.

and Luoyp, Carr & Co.,

Plaintiff s-A ppellants-A ppellees,

Wuuum T. Baciey, Chairman of the Commodity Futures

Trading Commission, Jonn V. Rarnsott, III, Vice

Chairman of the Commodity Futures Trading Commis-

sion, et al.,

Defendants-A ppellees-A ppellants.

Nationa, Association or Commopity Option Draters,

a non-profit association, et al.,

Plaintiff s-A ppellees,

NationaL Association oF Commopity Option Deauers, etc.

56a

Appendia E

It is hereby ordered that the motion made herein by

counsel for the appellants British American Commodity

Options Corp. and Lloyd, Carr & Co. by notice dated June 7,

1977 to stay issuance of the mandate pending application

to the Supreme Court of the United States for a writ of

certiorari pursuant to Rule 41(b) of the Federal Rules of

Appellate Procedure be and it hereby is granted, subject

to the provisions of FRAP 41(b);

It is further ordered that, within five days from the date

hereof, appellants post the bonds referred to at p. 9 of

the moving papers.

/s/ Wrurrep Fermsera

Wilfred Feinberg

/s/ Murray J. Gurren

Murray J. Gurfein

/s/ Tuomas J. Mesxmu

Thomas J. Meskill

Circuit Judges.

57a

Appendix F

(Principal Statutes Involved)

1. 5 U.S.C. § 553(d) :

“The required publication or service of a substantive

rule shall be made not less than 30 days before its effec-

tive date, except—

(1) a substantive rule which grants or recognizes an

exemption or relieves a restriction;

(2) interpretative rules and statements of policy; or

(3) as otherwise provided by the agency for good cause

found and published with the rule.”

5 U.S.C. §706 in pertinent part provides:

“To the extent necessary to decision and when presented,

the reviewing court shall decide all relevant questions

of law, interpret constitutional and statutory provisions,

and determine the meaning or applicability of the terms

of an agency action. The reviewing court shall—

(1) compel agency action unlawfully withheld or unrea-

sonably delayed ; and

(2) hold unlawful and set aside agency action, findings,

and conclusions of law found to be—

(A) arbitrary, capricious, an abuse of discretion,

or otherwise not in accordance with law;

(B) contrary to constitutional right, power, priv-

ilege, or immunity ;

or limitations, or short of statutory rights;

58a

Appendia F

(D) without observance of procedure required by

law;

(E) unsupported by substantial evidence in a case

subject to sections 556 or 557 of this title or

otherwise reviewed on the record of an agency

hearing provided by statute; or...

In making the foregoing determinations, the court shall

review the whole record or those parts of it cited by a

party, and due account shall be taken of the rule or

prejudicial error.”

. 7 U.S.C. §6e(b) :

“(b) No person shall offer to enter into, enter into, or

confirm the execution of, any transaction subject to the

provisions of subsection (a) of this section involving

any commodity regulated under this chapter, but not

specifically set forth in section 2 of this title, prior to

the enactment of the Commodity Futures Trading Com-

mission Act of 1974, which is of the character of, or is

commonly known to the trade as, an “option”, “priv-

ilege”, “indemnity”, “bid”, “offer”, “put”, “call”, “ad-

vance guaranty”, or “decline guaranty”, contrary to

any rule, regulation, or order of the commission pro-

hibiting any such transaction or allowing any such trans-

action under such terms and conditions as the Commis-

sion shall prescribe within one year after the effective

date of the Commodity Futures Trading Commission

Act of 1974 unless the Commission determines and no-

tifies the Senate Committee on Agriculture and Forestry

and the House Committee on Agriculture that it is

unable to prescribe such terms and conditions within

such period of time. Provided, That any such order,

59a

Appendia F

rule, or regulation may be made only after notice and

opportunity for hearing: And provided further, That

the Commission may set different terms and conditions

for different markets.”

. 7 U.S.C. §19 provides:

“The Commission shall take into consideration the pub-

lic interest to be protected by the antitrust laws and

endeavor to take the least anticompetitive means of

achieving the objectives of this chapter, as well as the

policies and purposes of this chapter, in issuing any

order or adopting any Commission rule or regula-

tion, or in requiring or approving any bylaw, rule, or

regulation of a contract market or registered futures

association established pursuant to section 21 of this

title.”

60a

Appendix G

(Principal Regulations Involved)

§32.3 Unlawful commodity option transactions.

(a) On and after January 17, 1977, it shall be unlawful

for any person to accept any money, securities, or property

(or to extend credit in lieu thereof) from an option cus-

tomer as payment of the purchase price in connection with

a commodity option transaction unless such person is reg-

istered as a futures commission merchant under the Act

and such registration shall not have expired, been sus-

pended (and the period of suspension has not expired) or

revoked.

(b) On and after January 17, 1977, it shall be unlawful

for—

(1) any person to solicit or accept orders (other

than in a clerical capacity) for the purchase or sale

of any commodity option, or to supervise any person

or persons so engaged, unless such person is—

(i) registered as a futures commission merchant

under the Act, or

(ii) if such person is an individual, registered as an

associated person of a specified futures com-

mission merchant under the Act;

and such registration shall not have expired, been sus-

pended (and the period of suspension has not expired)

or revoked; and

(2) any futures commission merchant to permit an

individual to become or remain associated with such

futures commission merchant as a partner, officer or

employee (or in any similar status or position involv-

6la

Appendiz G

ing similar functions) in any capacity involving such

solicitation, acceptance or supervision if such futures

commission merchant knew or should have known that

such individual was not registered as an associated

person or that such registration has expired, been

suspended (and the period of suspension has not ex-

pired) or revoked; ...

$32.4 Exemptions.

* @ @ es .

(b) The Commission may, by order, upon written request

or upon its own motion, exempt any other person, either

unconditionally or on a temporary or other conditional

basis, from any provisions of this Part, other than sections

32.2, 32.8 and 32.9, if it finds, in its discretion, that it would

not be contrary to the public interest to grant such ex-

emption.

* eo € * *

§32.6 Segregation.

(a) Any person which accepts money, securities or prop-

erty from an option customer as payment of the purchase

price in connection with a commodity option transaction

shall treat and deal with such money, securities and prop-

erty as belonging to such option customer until expiration

of the term of the option or, if the option customer exer-

cises the option, until all rights of the option customer

under the commodity option have been fulfilled. Such

money, securities, and property (1) shall be separately

accounted for and segregated as belonging to such option

customer, (2) shall be kept in the United States, and (3)

shall not be commingled with the money, securities or prop-

erty of any other person, including the money, securities

62a

Appendia G

or property received by a futures commission merchant to

margin, guarantee or secure the trades or contracts of

commodity customers (as defined in §1.3(k) of this chap-

ter) or with the money accruing to such commodity cus-

tomers as the result of such trades or contracts: Provided,

however, That the money, securities or property treated

as belonging to an option customer may for convenience

be commingled with the money, securities or property

treated as belonging to any other option customer and

deposited in the same account or accounts with any bank

or trust company in the United States. Such money, se-

curities and property, when so deposited with any hank or

trust company, shall be deposited under an account name

which will clearly show that it contains money, securities

or property, segregated as required by this Part. Each

person depositing such money, securities or property shall

obtain and retain in its files for the period provided in

§1.31 of this chapter an acknowledgment from such bank

or trust company that it was informed that the money,

«ocurities and property therein are being treated as be-

longing to option customers and are being held in accor-

dance with the provisions of this Part. Such bank or trust

company shall allow inspection of such accounts at any

reasonable time by representatives of the Commission:

Provided, further, That, up to a maximum of 10 percent

of the money, securities or property accepted from an

option customer as payment of the purchase price in con-

nection with a commodity option transaction need not be

treated and dealt with as belonging to the option customer

and segregated as aforesaid.

(b) No money, securities or property deposited in ac-

cordance with paragraph (a) of this section shall be held,

disposed of, used or treated as belonging to the depositing

63a

Appendia G

person or any person other than the option customers of

such person: Provided, however, That such money may be

invested in obligations of the United States, and in obli-

gations fully guaranteed as to principal and interest by

the United States. Such investments shall be made through

an account or accounts used for the deposit of money, se-

curities or property received from option customers and

proceeds from any sale of such obligations shall be re-

deposited in such account or accounts. Each person which

invests money belonging to option customers in obligations

as described in this paragraph (b), shall separately ac-

count for such obligations and segregate such obligations

as belonging to such option customers. Such obligations

may only be deposited with a bank or trust company in

the United States and shall be deposited under an account

name which will clearly show that it contains obligations

treated as belonging to option customers, segregated as

required by this Part. Each person depositing such obli-

gations shall obtain and retain in its files an acknowldg-

ment from such bank or trust company that it was in-

formed that the obligations are treated as belonging to

option customers and are being held in accordance with

the provisions of this Part. Such acknowledgment shall

be retained for the period provided in §1.31 of this chap-

ter. Such bank or trust company shall allow inspection of

the obligations at any reasonable time by representatives

of the Commission.

ing to option customers as permitted hereunder shall keep

a record showing the following: (1) the date on which

such investments were made, (2) the name of the person

through which such investments were made, (3) the amount

of money so invested, (4) a description of the obligations

64a

Appendia G

in which such investments were made, (5) the identity of

the depositories or other places where such obligations

are segregated, (6) the date on which such investments

were liquidated or otherwise disposed of and the amount

of money received on such disposition, if any, and (7) the

name of the person to or through which such investments

were disposed of.

(d) Persons which invest money in obligations described

in paragraph (b) of this section shall include such obliga-

tions in segregated accounts at values which at no time

shall be greater than current market value, determined as

of the close of the market on the last preceding market day.

(e) The deposit and/or investment of money as provided

in paragraphs (a) or (b) of this section shall not operate

to prevent the person so depositing and/or investing such

money from receiving and retaining as its own any incre-

ment or interest resulting therefrom.

(f) The amount of money, securities and property which

is and which must be in a segregated account in order to

comply with the requirements of this Part shall be com-

puted by each person required to segregate such money,

securities and property as of the close of each business

day. A record of such computation shall be made and kept,

together with all supporting data in accordance with the

provisions of 41.31 of this chapter. Such computation shall

be made prior to the opening of business on the next

business day.

$32.10 Option transactions entered into prior to the

effective date of this Part.

Nothing contained in this Part shal] be construed to af-

fect any lawful activities that occurred prior to the effec-

tive date of this Part.

65a

Appendia G

The foregoing adoption by the Commission of the amend-

ments to §§1.3 and 1.17, of the deletion of 430.01, and of

Part 32 shall become effective 15 days after the date this

Notice is published in the Federal Register (December ....,

1976), except that section 32.6 of Part 32 of the foregoing

rules shall become effective 30 days after the date of publi-

cation (December ...., 1976). In order to assure full and

fair consideration of the various proposals that have been

made over the many months in which option regulations

have been considered, it has not been possible to imple-

ment appropriate regulations before now. That consider-

ation having now been completed, however, the Commis-

sion finds that the public interest requires that the fore-

going rules be adopted without any further delay inasmuch

as the public has been without the protection of a compre-

hensive regulatory program in an area which historically

has been fraught with abuses. Moreover, there has been

ample notice and public participation in this rule-making

proceeding and affected persons have had adequate notice

and opportunity to comment on the subject of these rules

and the issues involved in their consideration, as well as

the terms of the rules themselves substantially as adopted.

Furthermore, affected persons have had an adequate op-

portunity, through prior notices, to take the necessary steps

to be in full compliance with the rules by the effective dates

thereof.

Issued in Washington, D.C. on November 22, 1976.

By the Commission.

/s/ Wuut1am T. Baciey

William T. Bagley

Chairman

Commodity Futures Trading

Commission

yee

66a

Appendix H

(Order of Court)

In THE

UNITED STATES DISTRICT COURT

For THe Nortueen District or GEoRGIA

Attanta Drvision

C77-643A

FRANKLAND CoMMODITIEs CORPORATION,

Plaintiff,

Commopiry Futures Traprixe Commission, et al.,

Defendants.

This is an action for injunctive and declaratory relief

brought by Frankland Commodities Corporation (Frank-

land) against the Commodity Futures Trading Commission

(CFTC) and the five individual Commissioners of the

CFTC. Jurisdiction is founded upon 28 U.S.C. $4 1344

(a)(2), 2201, and 2202 and the Administrative Procedure

Act, 5 U.S.C. §§551 and 553. Frankland seeks to enjoin

the enforcement of the segregation requirements contained

in 17 C.F.R. § 32.6. Frankland also seeks a declaratory

judgment on the grounds that the segregation provision

is null and void on the basis that it is arbitrary, capri-

cious, anticompetitive, void for vagueness, contrary to

public policy and that it will deprive plaintiff of its prop-

erty without due process of law. The Court, having heard

67a

Appendix H

oral argument on May 5, 1976, presently has before it

Frankland’s motion for a preliminary injunction.

On October 23, 1974, Congress enacted the Commodity

Futures Trading Commission Act of 1974 (Act), Pub. L.

93-463, 88 Stat. 1389, which established the CFTC as an

independent regulatory agency of the United States

charged with the responsibility for enforcing and admin-

istering the provisions of the Act.

The commodities business involves the trading of con-

tracts for the purchase or sale of specific amounts of a

commodity either that have already been produced, or that

will be produced in the future and delivered by a specific

date. The latter group of contracts are known as “com-

modity futures” and are freely traded in the commodities

marketplace. A “commodity option” is a contractual right

to buy or sell a commodity or commodity future by some

specific date at a specified price. Generally, an option is

created, or “written,” by the owner, or “grantor,” of a

commodity or commodity futures contract, who obligates

himself to sell his goods or contract.

Frankland does not engage in the sale of commodities

or commodity futures, but rather, deals only in options on

futures contracts for certain commodities that are traded

in London, England. Frankland solicits customers for Lon-

don options only in the United States. Onec Frankland

obtains an order for an option, Frankland requires that

its customer pay Frankland in full for the retail value of

the option. According to plaintiff, when Frankland receives

the customer’s money it purchases the option from a trader

on the London Option Market. Frankland’s cost for its

options is approximately 72 percent of the amount it re-

ceives from its customers, the remaining 28 percent becom-

ing profit.

68a

Appendia -H

The London Option Market is composed of members of

the International Commodity Clearing House (ICCH) and

the London Metal Exchange (LME). After execution of the

option the grantor is required to escrow or segregate 100

percent of the price of the option in special accounts with

the ICCH which guarantees fulfillment of each futures

option executed by its members.

In October 1975, the CFTC announced that it was con-

sidering rules to regulate or prohibit all options trading

under the authority granted to it under the Commodity

Futures Trading Commission Act, 7 U.S.C. 4 12a(5) (Supp.

V, 1975), and invited public comment. 40 Fed. Reg. 49360-

49362 (October 22, 1975). On February 20, 1976, the CFTC

published proposed temporary rules to govern commodity

options transactions, 41 Fed. Reg. 7774-7776 (February

20, 1976). These proposed temporary regulations did not

include a requirement that the United States option dealer

escrow or segregate any portion of the customer’s cash

payment until the option is sold or exercised. However,

the CFTC did indicate its interest in comments on such a

requirement. 41 Fed. Reg. 7776 (February 20, 1976).

On October 8, 1976, the CFTC published proposed in-

terim regulations, which included a segregation require-

ment, and invited public comment. 41 Fed. Reg. 44560,

44561, 44567 (October 8, 1976). The CFTC adopted these

regulations, substantially in the same form as proposed,

and gave public notice on November 24, 1976. 41 Fed. Reg.

51808-51810, 51815-51816 (November 24, 1976). The ef-

fectiveness of the segregation requirement was delayed 30

days.

Section 32.6 of these regulations requires a futures com-

mission merchant, such as Frankland, to segregate 90 per-

OOP PP ETN PO SRE

;

69a

Appendia H

cent of the payment received from the customer in a United

States bank account until expiration or exercise of the

option. But the London exchanges must simultaneously

be sent that portion of the customer’s money that repre-

sents the wholesale price of the option. Frankland, there-

fore, must itself have the funds to place a major portion

of the price of the option it sells in a segregated account

in the United States. Frankland contends that this “double

segregation” burden will require it to raise approximately

189,000 dollars per month, which may be impossible for it

to raise. See Affidavits of C. Jeffery Jacobs and Don F.

Barnes (filed May 5, 1977). Plaintiff claims that the seg-

regation regulation is anticompetitive in that it will force

smal] futures commission merchants out of business and

allow only the large houses, with substantial capital bases,

to remain operating. Frankland further contends that the

segregation requirement is not needed to protect Ameri-

can investors inasmuch as the London market has its own

system of customer safeguards.

The Second Circuit, in British American Commodity

Options Corp., et al. v. Bagley, et al., Civil Action Nos.

77-6010, 77-6011, 77-6019 (April 4, 1977), has upheld the

segregation requirement under attack in the instant action,

and the plaintiffs in that case have filed petitions for re-

hearing. The Second Circuit seriously questioned the pro-

tection afforded United States customers by the London

safeguards and found that the segregation requirement

was a reasonable exercise of the CFTC’s discretion in an

effort to protect the public from the abuses that have

plagued the commodity options industry.

In weighing any request for preliminary injunction, this

Court must be guided by the standards set forth by the

United States Court of Appeals for the Fifth Circuit in

70a

Appendic H

Canal Authority of State of Florida v. Callaway, 489 F.2d

567 (1974). The Court of Appeals there noted that, al-

though the granting of a preliminary injunction is discre-

tionary, the district court must exercise that discretion in

the light of four prerequisites:

“The four prerequisites are as follows: (1) a substan-

tial likelihood that plaintiff will prevail on the merits,

(2) a substantial threat that plaintiff will suffer ir-

reparable injury if the injunction is not granted, (3)

that the threatened injury to plaintiff outweighs the

threatened harm the injunction may do to defendant,

and (4) that granting the preliminary injunction will

not disserve the public interest.” (citation omitted)

489 F.2d at 572.

The Court of Appeals has also stressed the extraordinary

character of such relief:

“In considering these four prerequisites, the court must

remember that a preliminary injunction is an extraordi-

nary and drastic remedy which should not be granted

unless the movant clearly carries the burden of per-

suasion. The primary justification for applying this

remedy is to preserve the court’s ability to render a

meaningful decision on the merits.” Id. (citation omit-

ted)

Those standards are set forth in recognition of the fact

that the district court must decide whether to grant the

interim relief of a preliminary injunction without the bene-

fit of full discovery and consideration of the issues on the

merits that would occur at trial.

The Court is not entirely persuaded by the decision of

the Second Circuit and, therefore, is not of the opinion

7la

Appendia H

that plaintiff has not presented a substantial cause of ac-

tion. The Court does find, however, that Frankland has

not presented the Court with sufficient evidentiary docu-

mentation of the irreparable injury that will be caused by

the enforcement of the segregation regulation and, there-

fore, finds that Frankland has failed to carry its burden

of persuasion, as required by the Fifth Circuit, regarding

the threat of irreparable injury. Accordingly, plaintiff’s

motion for a preliminary injunction is hereby Denrep.

So Orperep, this 12 day of May, 1977.

/s/ Cuartes A. Moye, Jr.

United States District Judge

72a

Appendix I

(Order Granting Injunction Pending Appeal)

In THE

UNITED STATES DISTRICT COURT

For tHE NortHERN District or GEorGIA

Atiantic Drvision

Civil Action File No. 77-643A

FRaANKLAND CoMMODITIES CORPORATION,

Plaintiff,

vs.

Commopity Futures Trapinc Commission, et al.,

Defendants.

This cause came on to be further heard on motion of

plaintiff for an injunction pending appeal, and it appear-

ing to the Court that the relief herein granted is neces-

sary to preserve the status quo pending appeal by the

plaintiff to the U. S. Court of Appeals for the Fifth

Circuit for the reason that irreparable damage will result

to the plaintiff pending such appeal if the denial of plain-

tiff’s motion for preliminary injunction shall be reserved

on appeal,

Ir is Orperep that (provided Notice of Appeal is filed

by May 17, 1977 and prosecuted diligently and expeditiously

thereafter) until a hearing and determination of the ap-

peal herein to the U. S. Court of Appeals for the Fifth

Circuit, the defendants be and hereby are restrained from

73a

Appendia I

enforcing their Rule 32.6 (17 CFR 432.6) as to plaintiff,

and that the security in the amount of $25,000.00 deposited

with the Clerk of the Court by plaintiff as a condition

of the temporary restraining order issued in this action

shall continue to be deposited with the Court as security

for this injunction pending appeal conditioned upon the

faithful performance by plaintiff of its obligations to its

customers.

Ir Is So Onperep this 12 day of May, 1977.

/s/ Cuarntes A. Moyes, Jr.

Charles A. Moye, Jr.,

Judge, United States District

Court, Northern District of

Georgia

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