Opposition Brief — R&W Technical Services, Ltd. v. Commodity Futures Trading Commission

(J ‘JUL 24 2000

No. 99-1883

ie = =

In the Supreme Court of the Gite States—

R&W TECHNICAL SERVICES, LTD.

AND GREGORY M. REAGAN, PETITIONERS

Vv.

COMMODITY FUTURES TRADING COMMISSION

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

BRIEF FOR THE

COMMODITY FUTURES TRADING COMMISSION

IN OPPOSITION

SETH P. WAXMAN

Solicitor General

Counsel of Record

Department of Justice

C. ROBERT PAUL Washington, D.C. 20530-0001

General Counsel (202) 514-2217

GLYNN L. MAYs

Senior Assistant General

Counsel

MICHAEL J. GARAWSKI

At

Commodity Futures Trading

Commission

Washington, D.C. 20581

QUESTIONS PRESENTED

1. Whether petitioners were “commodity trading

advisor[{s]” under Section 1a(5) of the Commodity Ex-

change Act, 7 U.S.C. 1a(5).

2. Whether petitioners made misrepresentations

concerning the performance and use of their futures-

trading system “in connection with” any order to make,

or the making of, futures contracts, in violation of

Section 4b(a) of the Commodity Exchange Act, 7 U.S.C.

6b(a).

(I)

TABLE OF CONTENTS

Page

Opinions below 1

Jurisdiction 1

Statement 2

Argument .......... stamens 6

Conclusion sbi . 12

TABLE OF AUTHORITIES

Cases:

Commodity Trend Serv., Inc. v. CFTC, No. 97 C 2362,

1999 WL 965962 (N.D. Ill. Sept. 29, 1999), appeal

pending on other grounds, No. 99-4142 (7th Cir.) ........... ~

Ginsburg v. Agora, Inc. 915 F. Supp. 733 (D. Md.

TD wisacestniaitcecdpehanialitiaiepe ic 9

Hirk v. Agri-Research Council, Inc., 561 F.2d 96

(7th Cir. 1977) jas 11,12

Lowe v. SEC, 472 U.S. 181 (1985) .....cccccsscscsosscsssssssccsescneeees 7, 8,9

Saxe v. E.F. Hutton & Co., 789 F.2d 105 (2d Cir.

1986) 11

Schneider v. State, 308 U.S. 147 (1989) ..c.ccccccccccccccssssecssoees 8

Taucher v. Born, 53 F. Supp. 2d 464 (D.D.C. 1999),

dismissed, No. 99-5923, 2000 WL 516081 (D.C. Cir.

SO i NE ehisislesishctdsrasiiheisiicascacctenesahiestacabesmsetiendisndsuiiens 8

‘United States v. O’Hagan, 521 U.S. 642 (1997) ...........0... 10

Village of Schaumburg v. Citizens for a Better

eet, ne re I sii 8

Zauderer v. Office of Disciplinary Counsel, 471 U.S.

De IT Sacetips esiaspsaasncsniphensetchscheswicdednianasestiiascamsbcnkte ecelasssbs 8

Constitution, statutes and regulations:

I IIE Fic ssarsicshccicntnasebesminndebinsshetnsonyeccibonsdies 7,8

Commodity Exchange Act, 7 U.S.C. 1 et seq.:

Mees NE UNE rhachis sss dah scepescienbccioniesbabiecctnnsthiciondaciaenn 9

RP a MONIT: Sicintiedsinistisascensscspsonisinn iiiciniiensacainteiaansias 5, 6

7 U.S.C. 1a(5)(A)().. aio abanidesinehiionanioanasins 6

(III)

IV

Statutes and regulations—Continued:

7 U.S.C. 1a(5)(B)(iv)

~ TUS.C. 1a(5)(C)

7 U.S.C. 6b

7 U.S.C. 6b(a) .....

7 U.S.C. 6b(a)(i) :

7 US.C. 6b(a)(iii) ......

7 U.S.C. 6m(1)

7 U.S.C. 6n(3)(A)

FU BEC, CO csccscsnsssnssiniansssncosessscninonscussantnavncbsensiiansiniacisiesne

T U.S.C. 60(1) ......0.0000

7US.C. 17..

Investment Advisers Act of 1940, 15 U.S.C. 80b-1

et seq.:

15 U.S.C. 80b-2(a)(11)

15 U.S.C. 80b-2(a)(11)(D)

Securities Exchange Act of 1934 § 10(b), 15 U.S.C.

78(j)(b)

CFTC Rule 4.14(a)(9), 65 Fed. Reg. 12,938 (2000) (to

be codified at 17 C.F.R. 4.14(a)(9))

CFTC Rule 4.14(a)(9)(ii), 65 Fed. Reg. 12,938 (2000)

(to be codified at 17 C.F.R. 4.14(a)(9)Gi))

CFTC Rule 4.41(a), 17 C.F.R. 4.41(a)

Miscellaneous:

Robert L. Stern et al., Supreme Court Practice (7th ed.

1998) ......

Jn the Supreme Court of the Gnited States

No. 99-1883

R&W TECHNICAL SERVICES, LTD.

AND GREGORY M. REAGAN, PETITIONERS

Vv.

COMMODITY FUTURES TRADING COMMISSION

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

BRIEF FOR THE

COMMODITY FUTURES TRADING COMMISSION

IN OPPOSITION

OPINIONS BELOW

The opinion of the court of appeals (Pet. App. Al-

A48) is reported at 205 F.3d 165. The opinion and order

of the Commodity Futures Trading Commission (Pet.

App. A50-A174) is unofficially reported at [1998-1999

Transfer Binder] Comm. Fut. L. Rep. (CCH) 4 27,582.

JURISDICTION

The judgment of the court of appeals was entered on

February 24, 2000. The petition for a writ of certiorari

was filed on May 24, 2000. The jurisdiction of this

Court is invoked under 28 U.S.C. 1254(1).

(1)

2

STATEMENT

1. From April 1993 through March 1996, petitioners

sold computer software that generated trading signals

for commodity futures contracts. Pet. App. A3, A55.

Petitioners’ trading systems incorporated mathematical

formulas that purportedly identified exploitable price

trends. Using those formulas, the software analyzed

current price data from certain commodity markets and

produced trading recommendations that the user was

advised to act upon at the opening of trading on the

following day. Jd. at A3, A56-A61.

Petitioners solicited members of the public to

purchase their software primarily through advertise-

ments in Futures magazine. Pet. App. A63. In those

advertisements and other promotional materials, peti-

tioners claimed that the software consistently had

generated spectacular profits. Jd. at A38, A64-A66.

Petitioners bolstered such claims of actual trading

profits by representations that their profits data were

based on “account balance[s],” “bank balance[s],” and

“certified” trading results. Jd. at A8, A66n.14. The

promotional materials also represented that petitioners

sold the software to “increase [petitioners’] own trading

capital.” Jd. at A66-A67. Contrary to those representa-

tions, however, the trading results set forth in the

advertisements were based on hypothetical, simulated

trading results. Id, at A4, A68-A71.

On March 19, 1996, the Commission brought an

administrative enforcement action against petitioners

charging, inter alia, that they engaged in fraud in the

solicitation of customers, in violation of 7 U.S.C. 6b(a)(i)

and (iii); that they engaged in fraudulent sales practices

and fraudulent advertising, in violation of 7 U.S.C. 60(1)

and CFTC Rule 4.41(a), 17 C.F.R. 4.41(a); and that they

3

failed to register as commodity trading advisors, in

violation of 7 U.S.C. 6m(1). Pet. App. A51-A53.

On December 1, 1997, an administrative law judge

(ALJ) issued an initial decision finding that petitioners

were liable for all but one of the alleged violations. Pet.

App. A81-A84.’ -The ALJ ordered that petitioners

cease and desist from violating the Commodity Ex-

change Act (the Act) and the Commission’s regulations,

and that petitioners jointly and severally pay civil

monetary penalties in the amount of $7,125,000. Jd. at

A84-A87.

On March 16, 1999, the Commission affirmed in part,

modified in part and vacated in part the ALJ’s decision.

Pet. App. A49-A174. The Commission found that peti-

tioners intentionally misrepresented hypothetical trad-

ing results as actual trading results, misrepresented

their actual use of their trading systems, and mis-

represented the risks of futures trading by making

exaggerated predictions of profit along with guarantees

of profitability. The Commission affirmed the ALJ’s

‘conclusion that petitioners made those misrepre-

sentations “in connection with” any order to make

futures contracts, in violation of 7 U.S.C. 6b(a). Pet.

App. A124-A145. After concluding that petitioners fell

“within the plain meaning” of the statutory definition of

commodity trading advisors (id. at A108-A124), the

Commission also affirmed the ALJ’s conclusion that

petitioners engaged in fraud and deceptive advertising

as commodity trading advisors, in violation of 7 U.S.C.

60(1) and CFTC Rule 4.41(a), 17 C.F.R. 4.41(a). Pet.

App. A145-A148.

1 The ALJ found that petitioner R&W Technical Services, Ltd.,

had not violated the record-production requirements under 7

U.S.C. 6n(8)(A). Pet. App. A83.

4

The Commission ordered that petitioners cease and

desist from violating 7 U.S.C. 6b and 60 and CFTC Rule

4.41(a), 17 C.F.R. 4.41(a), and imposed civil monetary

penalties in the reduced amount of $2,375,000. Pet.

App. Al57-A158, A162-A171.. Viewing the case “pri-

marily as an action to enforce the antifraud provisions

of the Act and [its] regulations,” however, the Com-

mission found that it was unnecessary to reach the

merits of the charges of registration and record-

production violations. The Commission therefore va-

cated the ALJ’s cease and desist order pertaining to

those allegations. Jd. at A154, A158 n.57.

2. The court of appeals affirmed the Commission’s

finding of liability, but reversed and remanded the

Commission’s imposition of a monetary penalty. Pet.

App. Al-A48. The court first affirmed the Com-

mission’s liability findings under 7 U.S.C. 6b(a), which

prohibits any person from defrauding another person

“in connection with” an order to make, or the making of,

a commodity futures contract. Pet. App. A6-A24. In

reaching that conclusion, the court of appeals deferred ~

to the Commission’s interpretation-that fraud in the

sale of investment advice is “in connection with” the

sale of a commodity futures contract “if the fraud

relates to the risk of the trading and the primary pur-

pose of purchasing the advice is to execute trades.” Jd.

at A20. The court therefore held that it was “not unrea-

sonable” for the Commission to conclude that peti-

tioners’ misrepresentations to customers “regarding

the reliability of a system whose only intended use was

as a means of selecting commodity futures contracts”

occurred “in connection with” the making of commodity

futures contracts. Id. at A24. é

‘The court of appeals also affirmed the Commission’s

findings that petitioners violated 7 U.S.C. 60 and CFTC

5

Rule 4.41(a), 17 C.F.R. 4.41(a), which prohibit a “com-

modity trading advisor” from defrauding clients and

prospective clients. Pet. App. A24-A38. The court

observed (id. at A25) that 7 U.S.C. 1a(5)(A) defines a

“commodity trading advisor” as “any person who * * *

for compensation or profit, engages in the business of

advising others, either directly or through publications,

writing, or electronic media, as to the value of or the

advisability of trading in” commodity futures contracts.

The court also observed (Pet. App. A25) that although

the term “commodity trading advisor” does not include

any “publisher or producer of any print or electronic

data of general and regular dissemination,” that

exclusion applies only if “the furnishing of such services

* * * is solely incidental to the conduct of their

business or profession.” 7 U.S.C. 1a(5)(B)(iv) and (C).

The court of appeals rejected petitioners’ argument

that the reference in Section 1a(5)(C) to “such services”

refers only to “personalized advisory services.” It ex-

plained that “(t]he plain language” of the Act contains

no hint that the statutory reference to direct or indirect

advisory services is limited to personal advisory

services. Pet. App. A26. In the alternative, the court

held that the exclusion in Section 1a(5)(B)(iv) did not

apply to petitioners’ publications, because petitioners’

software was neither “generally” nor “regularly” dis-

seminated, as required by the exclusion. Jd. at A28-

A29,

2 The court of appeals also held that petitioners’ misrepre-

sentations were “material” under 7 U.S.C. 6b(a) (Pet. App. A6-

Al2), and that petitioners waived their contention that their

advertising did not defraud potential “clients” within the meaning

of 7 U.S.C. 60 and CFTC Rule 4.41(a), 17 C.F.R. 4.41(a) (Pet. App.

A35-A38). Petitioners do not challenge those rulings in this Court.

6

ARGUMENT

The decision of the court of appeals is correct and

does not conflict with any decision of this Court or any

other court of appeals. Further review is not war-

ranted. |

1. a. Petitioners argue (Pet. 5-9) that they were not

“commodity trading advisor[s]” within the meaning of

the Act because they fell within the exception in 7

U.S.C. 1a(5)(B)(iv) for publishers of print or electronic

data. That contention lacks merit.

The Act broadly defines a “commodity trading ad-

visor” as any person who “engages in the business of

advising others, either directly or through publications,

writings, or electronic media,” as to the advisability of

trading in futures contracts. 7 U.S.C. 1a(5)(A)(i)

(emphasis added). Section 1a(5)(B)(iv) provides that

“{s]ubject to subparagraph (C), the term ‘commodity

trading advisor’ does not-include * * * the publisher

* * * of any print or electronic data of general and

regular dissemination.” 7 U.S.C. 1a(5)(B)(iv). Section

1a(5)(C), entitled “Incidental services,” in turn provides

that “[s]ubparagraph (B) shall apply only if the furnish-

ing of such services by persons referred to.in sub-

paragraph (B) is solely incidental to the conduct of their

business or profession.” 7 U.S.C. 1a(5)(C).

As the court of appeals correctly concluded, the plain

-import of those provisions is that the publisher ex-

ception is available only if the advisory services

referenced in Section 1a(5)(A) are solely incidental to

the publisher’s business. See Pet. App. A26 (“Absent

any other distinctions, the later reference [in Section

1a(5)(C)j to ‘such services’ can only refer to both the

direct and indirect provision of advisory services.”).

Petitioners therefore do not fall within the publisher

7

—

exception, because their advisory activities were not

“solely incidental” to their exclusive business of mar-

keting software that advises users concerning com-

modity futures trading. See id. at A115.

Relying on this Court’s decision in Lowe v. SEC, 472

U.S. 181 (1985), which held that the Investment

Advisers Act of 1940, 15 U.S.C. 80b-2(a)(11), did not

apply to impersonal investment advisers, petitioners

argue (Pet. 6-9) that the phrase “such services” in

Section 1a(5)(C) refers only to “personalized” advisory

services. They further argue that their limiting

construction is necessary to avoid any constitutional

doubt about the Commodity Exchange Act’s registra-

tion requirements applicable to commodity trading

advisors. See 7 U.S.C. 6m(1). The court of appeals

properly rejected those contentions. Pet. App. A30-

A34.,

As an initial matter, the Court in Lowe construed a

different statute that excluded from the definition of an

investment adviser a “publisher of any bona fide news-

paper, news magazine or business or financial publi-

cation of general and regular circulation.” See 472 U.S.

at 204 (citing 15 U.S.C. 80b-2(a)(1 1)(D)). By contrast,

here the Commodity Exchange Act’s exclusion for

publishers applies only if the publisher’s rendering of

commodity trading advice is “solely incidental” to the

publisher’s business. 7 U.S.C. 1a(5)(C). Thus, the ex-

clusion for publishers from the definition of a com-

modity trading advisor is, on its face, narrower than the

exclusion addressed in Lowe.

Moreover, there is no reason to ignore the plain text

of Section 1a(5)(C) to avoid construing the Act to

infringe upon petitioners’ First Amendment rights.

The statutory definition of a “commodity trading

advisor” itself raises no First Amendment concerns,

8

and petitioners do not and cannot claim any First

Amendment, interest in their fraudulent advertising.

See Pet. App. A33 (citing Lowe, 472 U.S. at 225

(White, J., concurring); Zauderer v. Office of Dis-

ciplinary Counsel, 471 U.S. 626, 651 (1985); Village of

Schaumburg v. Citizens for a Better Env’t, 444 US.

620, 637-688 (1980); and Schneider v. State, 308 U.S.

147, 164 (1939)).

Petitioners’ only constitutional claim relates to the

Act’s registration requirements applicable to com-

modity trading advisors. Pet. 8-9.° The Act’s reg-

istration provisions, however, are not at issue in this

case, because the Commission did not find that peti-

tioners violated the registration requirements. See

Pet. App. A32, A154, A158 n.57. Thus, “even if the

registration requirements are unconstitutional, the rest

of the [Commodity Exchange Act] would remain intact

under [the] severability clause [in 7 U.S.C. 17].” Jd. at

8 Two district courts have concluded that the Act’s registration

requirements may not constitutionally be applied to require pub-

lishers of “impersonal” commodity trading advice to register with

the CFTC. Taucher v. Born, 53 F. Supp. 2d 464, 481-482 (D.D.C.

1999), dismissed, No. 99-5298, 2000 WL 516081 (D.C. Cir. Mar. 28,

2000); Commodity Trend Serv., Inc. v. CFTC, No. 97 C 2362, 1999

WL 965962, at *12-"14 (N.D. Ill. Sept. 29, 1999), appeal pending on

other grounds, No. 99-4142 (7th Cir.). The Commission thereafter

- adopted CFTC Rule 4.14(a)(9), 65 Fed. Reg. 12,988 (2000) (to be

codified at 17 C.F.R. 4.14(a)(9)), which provides regulatory relief

from the registration requirement for, inter alia, the types of

publishers at issue in those cases. The language of the rule and its

preamble suggest that, given the record in this case, petitioners

also would be exempt from the Act’s registration requirement.

CFTC Rule 4.14(a)(9)(ii) (to be codified at 17 C.F.R. 4.14(a)(9)(ii));

see also 65 Fed. Reg. at 12,941 (Example B).

9

A382. Nor does petitioners’ statutory claim, on which

there is no circuit conflict, warrant this court’s review.‘

b. In any event, petitioners do not contest the court

of appeals’ alternative holding (Pet. App. A28-A29)

that petitioners do not qualify for the publisher ex-

clusion because their “software publishing was neither

‘generally’ nor ‘regularly’ disseminated,” as required by

Section 1a(5)(B)(iv). This Court in Lowe, 472 U.S. at

209, explained that the term “regular” under the broad

exception for publishers in the Investment Advisers

Act of 1940 requires the absence of any “indication that

[the publications] have been timed to specific market

activity.” Here, the trading signals in petitioners’

software were tied to price trends occurring in the

futures markets. See Pet. App. A28 (“[T]Jhe petitioners’

recommendations were provided by software that was

programmed to ‘speak’ only when certain market con-

ditions were met.”). Moreover, petitioners’ so‘tware

was not “generally” disseminated, because “pe‘itioners

advertised that the software would only be sold in

limited numbers.” Jd. at A29; see also id. at A113.

2. a. Petitioners further argue that they cannot be

liable for engaging in fraud “in connection with any

order to make, or the making of, any [futures con-

tract],” 7 U.S.C. 6b(a), because their misrepresenta-

tions were not made “in connection with any individual

* Petitioners concede (Pet. 7) that the decision below does not

conflict with any appellate decision. Although they point out that

one district court has concluded that Section 1a(5) excludes pub-

lishers of impersonal commodity trading advice, see Ginsburg v.

Agora, Inc., 915 F. Supp. 733, 737-738 (D. Md. 1995), the existence -

of that conflicting district court decision does not warrant this

Court’s review. Robert L. Stern et al., Supreme Court Practice

§ 4.8, at 178 (7th ed. 1993).

10

or specific commodity futures transactions.” Pet. 11.

That contention, too, lacks merit.

Although petitioners did not execute trades for

customers, the Commission reasonably viewed peti-

tioners’ fraudulent sales of commodity trading advice to

be “in connection with” commodity trading, because

“the fraud relates to the risk of the trading and the

primary purpose of purchasing the advice is to execute

trades.” Pet. App. A20. As the court of appeals

explained, “petitioners’ advertising claims misrepre-

sented the fundamental risk associated with commodity

futures investments and trading systems.” Jd. at A17.

Moreover, petitioners’ “expensive software had no

purpose except as a device for choosing which trades to

make,” and petitioners “necessarily expected their

customers to make trades.” Jd. at A20. Finally,

petitioners “misled potential purchasers of their system

concerning trading profits and trading risks in order to

induce customers to trade, and there is ample evidence

to show that they did trade.” Jd. at A21-A22. The

court of appeals therefore correctly concluded that

“defraud[ing] customers regarding the reliability of a

system whose only intended use was a means of

selecting commodity futures contracts” is conduct that

occurs “in connection with” the making of commodity

futures contracts. Jd. at A24.

Petitioners err in suggesting (Pet. 12) that the court

of appeals’ holding conflicts with United States v.

O’Hagan, 521 U.S. 642, 656 (1997). The Court in

O’Hagan held that the phrase “in connection with”

under Section 10(b) of the Securities Exchange Act of :

1934, 15 U.S.C. 78j(b), was satisfied by allegations that

an attorney, without disclosure to his principal, used

misappropriated information to buy or sell securities.

521 U.S. at 656. In those circumstances, the Court

11

explained, “(t]he securities transaction and the breach

of duty * * * coincide.” Ibid. O’Hagan neither

purports to define the limits of the “in connection with”

requirement outside the misappropriation context nor

suggests that the requirement would not be satisfied by

fraudulent conduct that is calculated to cause its victims

to engage in market trading.

b. Petitioners argue (Pet. 12-13) that the decision

below conflicts with Saxe v. E.F. Hutton & Co., 789

F.2d 105, 109-111 (2d Cir. 1986), and Hirk v. Agri-

Research Council, Inc., 561 F.2d 96, 103-104 (7th Cir.

1977). Contrary to petitioners’ contention, however,

neither of those decisions construed the “in connection

with” requirement in Section 6b “to mean that the

fraudulent misrepresentation must concern the funda-

mental nature of a particular order or sale of a futures

contract, such that the fraud must involve the quality of

or the risks associated with the investment.” Pet. 13.

Rather, in Saxe, 789 F.2d at 110-111, the Second Circuit

simply held that the “in connection with” requirement

was satisfied when an E.F. Hutton employee convinced

a customer to open a trading account with a commodity

trading advisor by misrepresenting the advisor’s

abilities and the quality and degree of risk in the

advisor’s trading program. See Pet. App. A19 (“In the

instant case, the petitioners’ misrepresentations re-

garding the reliability of their system are analogous to

the broker in Saxe misrepresenting another broker’s

track record.”).

Similarly, in Hirk, 561 F.2d at 103, the Seventh

Circuit found that the “in connection with” requirement

was satisfied when securities brokers solicited an

investor to open a discretionary futures trading account

with a company by misrepresenting the profitability of

the company and its managed accounts, the competency

12

and experience of the company’s analysts, and the total

amount that the investor could lose. The court of

appeals specifically rejected the notion that the “broad”

phrase “in connection with” requires “conduct related

to persuading a customer to purchase a commodities

futures contract or in reporting to a customer the

status of the contract or the trading.” Ibid. Thus, there

is no conflict in the circuits warranting this Court’s

review. See Pet. App. A24 (observing that the Com-

mission’s interpretation of the “in connection with”

requirement “does not conflict with any earlier inter-

pretation by the federal courts”).

CONCLUSION i

The petition for a writ of certiorari should be denied.

Respectfully submitted.

SETH P. WAXMAN -

Solicitor General

C. ROBERT PAUL

General Counsel

GLYNN L. MAYS

Senior Assistant General

Counsel

MICHAEL J. GARAWSKI

Attorney

Commodity Futures Trading

Commission

JULY 2000