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EVANSTON BANK v. CONTICOMMODITY SER.

December 10, 1985

THE EVANSTON BANK, PLAINTIFF,
v.
CONTICOMMODITY SERVICES, INC., AND TED THOMAS, DEFENDANTS.



The opinion of the court was delivered by: Moran, District Judge.

    MEMORANDUM AND ORDER

In late May of 1982 the board of directors of the Evanston Bank discovered that the bank had lost over $1,200,000 in about one year of trading in commodities, while paying over $270,000 in commissions. The bank now brings this action for commodities fraud against ContiCommodity Services, Inc. (Conti), the futures commission merchant through which it traded in commodity futures, and Ted Thomas, the broker who handled its account.*fn1

The bank's version of how the loss occurred appears in the six counts of its complaint. Counts I and II allege violations of the Commodity Exchange Act (CEA), 7 U.S.C. § 1 et seq., specifically that Conti and Thomas used the bank's account for unauthorized trading and "churned" it (traded it excessively) to generate unnecessary commissions. The bank maintains that it intended only to hedge in commodities as a protection against rising interest rates, a conservative investment strategy. It says that it got speculative trading instead. Since Conti and Thomas used the mails and the telephone in connection with the trading, count IV alleges mail and wire fraud in violation of 18 U.S.C. § 1961 et seq., the Racketeer Influenced and Corrupt Organization Act (RICO). The remaining counts are pendent claims under Illinois law. Count III, for common law fraudulent misrepresentation and concealment, and count V, for fraudulent or deceptive business practices under Ill.Rev.Stat. ch. 121 1/2 ¶ 262, rest on Thomas' alleged assurances that the bank's account would be traded in accordance with appropriate banking regulations and Federal Deposit Insurance Corporation (FDIC) policies, and that the bank would be charged commissions at the same rate as other banks. Since an FDIC policy statement in effect then and now allows hedging in commodities but strongly discourages banks from speculative trading, and the bank was charged $94 per "round turn" (per transaction) while other Conti customers with similar account activity were charged $30 to $35 (and apparently some banks with other firms had a rate of only $11 to $20), the bank claims fraud and deception. Finally, count VI, apparently in the alternative, alleges negligence in the handling of the bank's account.

Conti, however, presents a different version of how the loss occurred and moves for summary judgment in its favor. The board of directors of the bank fully authorized Richard Christiansen, at that time both the chairman of the bank's board of directors and the bank's chief executive officer, to handle commodities trading for the bank. Conti maintains that all of the trades followed Christiansen's instructions on the bank's objectives and the overwhelming majority of them were either specifically approved or later ratified by him. Christiansen also executed a power of attorney to Thomas to make trades on behalf of the bank. The bank may now regret its choice of Christiansen as its agent (he was fired in June 1982, after the rest of the board discovered the extent of his trading), but nevertheless it chose him and so must bear the loss from his acts. And, if any further authority is needed, Conti points out that it strictly complied with the bank's instructions to send daily written confirmation of each trade to the cashier of the bank, Hindrek Ott. Neither Ott nor any other representative of the bank disavowed any trade until May 28, 1982. Since the bank was fully informed, both through its agent Christiansen and through the notice to the cashier, Conti argues, its silence ratified the trades. Therefore, Conti is not liable for the bank's losses as a matter of law. Defendant Thomas has moved to adopt Conti's motion.

This court finds to the contrary that, at least on the evidence now before us, this case needs a trial to resolve a host of unanswered questions. The primary purpose of summary judgment is to avoid the expenditure of time and money on a trial in cases where a trial would serve no real function. Mintz v. Mathers Fund, Inc., 463 F.2d 495 (7th Cir. 1972). Summary judgment should not be granted when facts or the inferences to be derived from facts are in dispute, because finding facts and drawing inferences are tasks for a trier of fact. United States v. Diebold, Inc., 369 U.S. 654, 82 S.Ct. 993, 8 L.Ed.2d 176 (1962); Wang v. Lake Maxinhall Estates, Inc., 531 F.2d 832 (7th Cir. 1976). Some inquiries by their very nature are fact-intensive. Fraud, for example, involves questions of intent and knowledge, which are normally questions for a trier of fact. If a reasonable person could draw more than one inference from the known facts, summary judgment is not appropriate. Rock Island Bank v. Aetna Casualty and Surety Co., 706 F.2d 219 (7th Cir. 1983). Agency questions also tend to be fact intensive. A third party dealing with an agent has a legal obligation to verify both the fact and the extent of the agent's authority. Malcak v. Westchester Park District, 754 F.2d 239, 245 (7th Cir. 1985). The inquiry will usually focus on whether reliance on the indications of authority which were present was reasonable under all the facts and circumstances. Such questions of reasonableness also in most cases must go to triers of fact. See e.g., Borg-Warner Leasing v. Doyle Electric Co., 733 F.2d 833, 836 (11th Cir. 1984); Moreau v. James River-Otis, Inc., 767 F.2d 6, 9 (1st Cir. 1985). This case involves both allegations of fraud and questions of agency. It cannot be cut off at this point.

I. FACTS

The complexity of the case requires that the facts be set out in considerable detail. In March 1981 Conti conducted a seminar on commodities trading especially tailored for financial institutions. Thomas, then head of Conti's broker training program and soon to be an account executive in Conti's Chicago office, participated. Christiansen, accompanied by Michael McGreal, the Evanston Bank's president, attended the seminar. Neither had any previous experience in trading commodities but Christiansen, who had read an article on the subject, wanted the bank to consider trading futures contracts in order to hedge the bank's assets against interest rate fluctuations.*fn2

Thomas contacted Christiansen and McGreal soon after the seminar. There is some dispute as to the exact characterization Thomas gave of himself at that point in his effort to win the bank's business. McGreal says that Thomas held himself out as a specialist in hedging for financial institutions. Thomas maintains that he represented himself merely as "knowledgeable" and "attempting to specialize." His knowledge came from one seminar on banks and commodities trading held the year before, and Thomas now admits that he was not familiar with the language of specific regulations and FDIC policy statements. During the next year the Evanston Bank was in fact his only bank client, although he had previously handled the account of one other bank. What Thomas felt he understood at that time was that banks could not open speculative accounts but could have hedge and arbitrage accounts.*fn3 An FDIC policy statement of November 20, 1979, permits banks to hedge on financial futures to protect against interest rate fluctuations, but describes other transactions "such as taking futures positions to speculate on future interest rate movements" as "inappropriate futures transactions for banks." 44 Fed.Reg. 66673; amended at 45 Fed.Reg. 18116 (March 20, 1980) and at 46 Fed.Reg. 51302 (Oct. 19, 1981). Under 12 U.S.C. § 1818, conduct contrary to FDIC policy can result eventually in a bank's losing its insured status with the FDIC, which in turn would mean loss of federal insurance protection for its depositors and loss of membership in the Federal Reserve System.

The bank opened a commodity futures hedge account with Conti on May 19, 1981. The board had endorsed a corporate authorization, a standard form furnished by Conti. By its terms, the bank authorized Christiansen and McGreal to buy and sell commodities for the bank, with written confirmations to go to the cashier, Ott, "who is hereby authorized to receive and acquiesce in the correctness of such confirmations, statements and other records and documents." Christiansen then completed a standard customer's agreement and a risk disclosure statement, a new account worksheet and a hedging account designation form. According to the latter, "Any and all positions in the above-mentioned account will be bona fide hedges as defined in Regulation 1.3(2) of the Commodity Futures Trading Commission (CFTC)." McGreal asserts, and Thomas apparently does not deny, that at the time the account was opened Thomas said that the bank's account would be traded in such a fashion that there would be no problem with any relevant regulations for banks, including FDIC policies, and that Evanston Bank would be charged the same commissions that other banks trading through Conti were charged. McGreal and Christiansen told Thomas at that time that the bank's investment objective was to hedge the bank's assets against rising interest rates — a very conservative strategy of acquiring futures contracts to sell ("shorts") corresponding to assets held by the bank — and that the bank would "rather be safe than sorry."*fn4 The first activity in the account was on June 2, 1981.

From July 1981 through December 1981 all parties agree that trading in the bank's account was consistent with those objectives. It averaged 22.8 transactions per month and was profitable. Thomas left Chicago to become branch manager of Conti's Houston office at the beginning of August, but continued to handle the Evanston Bank's account. A few days before he left, on July 27, Christiansen executed a document in the bank's name which gave Thomas a power of attorney over the bank's account. The origin of this document is disputed. Thomas maintains that it came in response to a concern voiced by Christiansen and McGreal that Thomas would be unable to reach them by telephone at a crucial time. McGreal disavows such a concern, and both deposition testimony and board minutes show that the board was unaware of any such document's existence throughout the period of the bank's trading. Christiansen's deposition testimony is silent on this and all other disputed matters since he relied upon his privilege against self-incrimination to decline to answer virtually all questions. The document made the bank's account a "discretionary account," a status not encouraged by Conti's own policy manual. According to Thomas, he used his authority for a few trades over the life of the account, but most came as a result of frequent telephone conversations with Christiansen.

The pattern of trading began to shift in January of 1982. In that month the bank's activity included 150 contracts in day trades, more day trades than had been placed during the entire life of the account up to that time.*fn5 Approximately that volume of trading persisted through February. Then in March activity took another quantum jump, with 326 contracts day-traded. From January until the board halted all trading at the end of May, the monthly average was 297.8 trades, over ten times the average for the previous six months. Although Thomas declines to call this trading "speculative," he agrees that it was a change in position in the futures market seeking higher yield. The bank's net "open positions" in its account with Conti shifted from an overall short position in January to $27,000,000 long at the end of April. According to Irving Hankin, an expert witness whose affidavit was submitted by the bank, this trading pattern was speculative and quite inconsistent with the bank's original objectives.*fn6 Since commissions were charged per transaction, this pattern also generated substantial commissions for Conti and Thomas, for example a larger charge for commissions in the month of March alone than for all trading in the account in 1981. The account's increased activity brought no reduction in the rate which the bank paid. By Thomas' admission, large volume customers normally were charged lower commission rates. Hankin found the commissions "atypically large."

According to Thomas, the shift in trading resulted from Christiansen's instructions to change the bank's investment strategy. Though he is not clear on the precise date, at some point in early 1982 Christiansen approached him with the question of whether it was feasible to make day trades for profit; told that it was, he authorized Thomas to make such day trades. Thomas says that Christiansen informed him that the bank needed to generate profits in order to meet a major debt which was coming due. Indeed, the bank's holding company, Evco, faced a quarterly payment on a $1,350,000 loan. It had intended to meet the payment with bank stock dividends, but, in March, the Commissioner of Banks denied permission to issue a dividend because the bank had not been sufficiently profitable. All bank personnel, however, deny that the board ever looked to commodities trading to generate the amount due, or in any other way changed its investment strategy for commodities. If Christiansen indeed ordered such a change, he seems to have concealed it from the board. He also apparently lied to the bank's asset and liability committee about the size and nature of the bank's trading. The loan to Evco was secured by bank stock and Christiansen's personal guarantee.

Another apparent effort to infuse cash into Evco came in late April and May. Christiansen also was the bank's chief loan officer. The bank loaned $50,000 to Thomas, who then used the funds to purchase Evco stock. The loan was issued to Thomas' Illinois bank account, though he had then lived in Houston for several months. The 800 shares of Evco stock were actually paid for by and issued to Thomas' wife in her maiden name, which she had not used for business for over 20 years. Thomas says that these arrangements were Christiansen's idea, "to avoid unnecessary questions from the bank examiners."

In any case, daily reports of the increased trading went to Ott, the cashier. Ott testified by deposition that his only responsibilities towards these reports on Christiansen's instructions, were to "book the entries," to post the gains and losses on the bank's general ledger, and then to put the statements into a file. The Evanston Bank did not have a regular cashier's report. The board reviewed only the monthly statements, not the daily ones. By opening and closing a position on the same day, the trading pattern eliminated the need for margin calls on the bank.*fn7 Thomas admits that the motive for some trades was to avoid margin calls. The directors did not actually know the bank's true position until late May. When they did, the board first ordered Christiansen to stop trading on May 28 and then began liquidating as rapidly as it could without absorbing so much of a loss as to make it insolvent. Christiansen was terminated by June 15. Conti fired Thomas in September, by his testimony for matters not related to the Evanston Bank account.

II. THE TRADING IN LIGHT OF FEDERAL AND STATE LAW

Conti's and Thomas' assertions in support of their motion for summary judgment fall broadly into two categories which this discussion will analyze separately. First, they maintain that regardless of the role of Christiansen or any ratification, their conduct did not rise to a level which would make them legally liable for commodities fraud. This section will analyze that argument. Secondly, even if they would otherwise be liable, the bank authorized all Conti's and Thomas' acts either through the power of attorney, through Christiansen, or through ratification by the bank's silence after notice. Section III will explore the agency problems. Both sections, however, deal with the same ultimate question: whether judgment can be granted now as a matter of law or must await a trier of fact.

A. Commodities Fraud and RICO

1. Liability under the CEA

Count I seeks to impose liability on Thomas for unauthorized trading and on Conti both directly and vicariously for its employee's acts. Conti's direct liability would result from its alleged aiding and abetting of Thomas, its failure to supervise its broker with procedures which would have brought his conduct to light, and its failure to investigate the investment objectives and financial resources of its client the bank to make sure its investments were suitable, as required by trade regulations. Conti argues, however, that it cannot be directly liable since even if proved true, none of those allegations states a claim under the Commodities Exchange Act as applied to losses incurred in 1982.

The CEA provides for enforcement of its provisions largely through the administrative agency it created, the CFTC. The express private right of action under the CEA, 7 U.S.C. § 25, was enacted by Congress only in the Futures Trading Act of 1982, P.L. 97-444 § 235, 96 Stat. 2322 (1982). It was not in effect during the period of the bank's losses. The Supreme Court has held that the general provision against commodities fraud, 7 U.S.C. § 6b, includes an implied private right of action for both acts expressly prohibited by that provision and acts prohibited by some regulations promulgated under it. Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, 102 S.Ct. 1825, 72 L.Ed.2d 182 (1982). However, courts which have dealt with the question have found significant limits on that implied right of action. In Curran, the court reasoned that since Congress amended the CEA in 1974 aware that courts were finding private rights under it, and did nothing to correct that impression, it must have implicitly adopted the law as it found it into the CEA. 456 U.S. at 378-82, 387, 102 S.Ct. at 1839-41, 1843. In interpreting Curran, then, lower courts have concluded that the implied private right delineated by that decision is limited to those actions which the law recognized in 1974. Any action based on a theory of recovery not recognized in 1974 — which includes most breaches of CFTC regulations — must be independently analyzed under the familiar tests of Touche Ross & Co. v. Redington, 442 U.S. 560, 99 S.Ct. 2479, 61 L.Ed.2d 82 (1979), and Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975). See J.E. Hoetger & Co. v. Asencio, 558 F. Supp. 1361 (E.D.Mich. 1983). So, courts have failed to find any pre-1982 right of action based on aiding and abetting, Johnson v. Chilcott, 590 F. Supp. 204 (D.Colo. 1984), failure to supervise, Bennett v. E.F. Hutton Co., 597 F. Supp. 1547 (N.D.Ohio 1984), or failure to find investments suitable to the customer, Asencio, 558 F. Supp. at 1364. Cf. Cardoza v. CFTC, 768 F.2d 1542 (7th Cir. 1985). This court concludes that the bank has no action against Conti for a breach of any of these.

It does not follow, however, that Conti could not be found liable. The CEA makes brokerage firms vicariously liable for the CEA violations of their agents, whether authorized or not, as long as the agent was "acting for" the firm at the time. 7 U.S.C. § 4; Poplar Grove Planting and Refining Co. v. Bache Halsey Stuart, Inc., 465 F. Supp. 585 (M.D.La.), remanded on other grounds 600 F.2d 1189 (5th Cir. 1979). The Supreme Court in Curran specifically held that the implied right of action under the CEA includes actions for fraud, deceit or misrepresentation. 7 U.S.C. § 6b; Curran, 456 U.S. at 389-90, 102 S.Ct. at 1844-45. If Thomas were found liable for commodities fraud, Conti would also be liable.

The § 6b action, however, requires intentional or reckless conduct similar to the scienter element of common law fraud. Since the term "willfully" occurs four times in § 6b, and since its function roughly parallels that of the antifraud provision of the Securities Exchange Act, 15 U.S.C. § 78j(b), which has already been construed to cover only intentional misrepresentation, most courts construing the CEA have found that liability for commodities fraud must be based on more than negligence. See McIlroy v. Dittmer, 732 F.2d 98 (8th Cir. 1984); CFTC v. Savage, 611 F.2d 270 (9th Cir. 1979). While the broker or house need not have had a demonstrably evil motive or an affirmative intent to injure customers — a fiduciary's breach of duty in appropriate circumstances is constructive fraud — nevertheless most courts, before finding a § 6b violation, look for at least knowing and deliberate conduct. See Marchese v. Shearson Hayden Stone, Inc., 734 F.2d 414 (9th Cir. 1984); Silverman v. CFTC, 549 F.2d 28, 31 (7th Cir. 1977); Haltmier v. CFTC, 554 F.2d 556 (2d Cir. 1977). The standard for private actions in both the Ninth and the First Circuits is intentional or willful conduct, including acting with knowledge of a false statement or an omission, or acting with reckless disregard of the falsity or omission. Yopp v. Siegel Trading Co., Inc., 770 F.2d 1461, 1464 (9th Cir. 1985); First Commodity Corp. of Boston v. CFTC, 676 F.2d 1, 6 (1st Cir. 1982). Recklessness has been defined in this context as conduct which "departs so far from the standards of ordinary care that it is very difficult to believe that the speaker was not aware of what he was doing." First Commodity, 676 F.2d at 7. Such a standard closely parallels the standard in the Seventh Circuit for securities fraud actions, Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1044 (7th Cir.), cert. denied, 434 U.S. 875, 98 S.Ct. 225, 54 L.Ed.2d 155 (1977), and so would probably be adopted here for commodities fraud as well. See Crook v. Shearson Loeb Rhoades, Inc., 591 F. Supp. 40 (N.D.Ind. 1983). But see Gordon v. Shearson Hayden Stone, Inc., Comm.Fut.L.Rep. (CCH) ¶ 21,016 (CFTC 1980) (CFTC uses negligence standard).

2. Unauthorized Trading

A genuine issue of fact exists as to whether Thomas' conduct in trading the bank's account could be characterized as intentional or reckless. Thomas, as the bank's broker, owed it a fiduciary duty, and that is a factor in the analysis. Marchese, 734 F.2d at 418; Crook, 591 F. Supp. at 48. A breach of a broker's fiduciary duty is not in every instance also a § 6b violation, Hagstrom v. Breutman, 572 F. Supp. 692, 697 (N.D.Ill. 1983), but when the breach appears intentional or reckless, and seems to benefit the broker at the expense of the client, as in the case at bar, it usually is grounds for a § 6b recovery. Crook, 591 F. Supp. at 48. For example, ignoring a client's express trading instructions is conduct so far from the ordinary standard of care that it must be either intentional or reckless. When a broker promised his customer that he would trade a discretionary account in a particular manner, and then repeatedly failed to do so, the conduct was both a breach of fiduciary duty and a violation of the CEA. McIlroy, 732 F.2d at 103-04. It is undisputed that Thomas initially promised to hedge the Evanston Bank account. Despite Thomas' reluctance to characterize the 1982 trades as speculative, there can be no genuine issue that they were. For the bank, any net long position was speculative and its account was $27,000,000 long. Unless a trier of fact found that Christiansen's agency, or a ratification theory, worked to release Thomas from that promise, it could infer unauthorized trading from these facts.

Also, a conscious decision not to disclose an objectively obvious danger to a client is reckless non-disclosure, which for a fiduciary amounts to misrepresentation or deceit. Sundstrand, 533 F.2d at 1047-1048. A trier of fact could infer that Thomas knew that the trades he made after January 1982 presented an obvious danger to the bank, given the FDIC policy with which he was at least somewhat familiar, and consciously decided not to inform his principal of that danger. If the agency issues were resolved against Conti, then a trial could find that Thomas breached his duty through unauthorized trading and reckless nondisclosure, and Conti would be liable as well.

3. "Churning"

  A similar analysis holds for count II. Churning has been
defined as excessive trading in an account over which the
broker has control for the primary purpose of generating
commissions. Yopp, 770 F.2d at 1465. Churning is a particular
species of unauthorized trading which provides a separate and
additional claim when high commission charges stem from an
amount of trading that exceeds what is appropriate for the
client's investment goals. Such trading, of course, breaches a
broker's fiduciary duty. Id. Churning was part of the
"contemporary legal context" in 1974 and is therefore included
in the implied right of action for fraud, misrepresentation or
deceit under § 6b. Curran, 456 U.S. at 381, 389, 102 S.Ct. at
1840, 1844. See, e.g., Hagstrom, 572 F. Supp. at 698; Booth v.
Peavey Co. Commodity Services, 430 F.2d 132 (8th Cir. 1970);
Johnson v. Arthur Espey, Shearson, Hammill & Co., 341 F. Supp. 764
 (S.D.N.Y. 1972). The elements of an action for churning a
commodities account are the same as in securities transactions.
While there is no single test or formula, generally a plaintiff
must show (1) broker control of the account, and (2) excessive
trading of the account which was (3) intentional or willful,
i.e., for the purpose of generating unnecessary commissions or
at least with reckless disregard for the client's interest. See
Yopp, 770 F.2d at 1466, applying Mihara v. Dean Witter & Co.,
619 F.2d 814 (9th Cir. 1980); Costello v. Oppenheimer & Co.,
711 F.2d 1361, 1368 (7th Cir. 1983); Armstrong v. McAlpin,
699 F.2d 79, 91 (2d Cir. 1983). Usually the intent or recklessness
will be implicit in the nature of the conduct. Armstrong, 699
F.2d at 91.

The facts before the court, at the very least, could raise an inference of churning. Since the account was discretionary, Thomas presumptively had control. Cf. Yopp, 770 F.2d at 1466; Costello, 711 F.2d at 1368. The amount of trading in 1982 massively exceeded that of 1981. It generated commissions described by plaintiff's expert as "atypically high," charged at a rate which Thomas admits was significantly higher than that which other customers with similar activity levels paid. Liability then would turn on whether the trading was consistent with the client's objectives. Compare Costello, 711 F.2d at 1368 with Fey v. Walston & Co., 493 F.2d 1036, 1045, 1048 (7th Cir. 1974). That question is a question of fact. In this case it can only be answered after a resolution of the same agency questions that apparently control count I: ...


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