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Cunningham v. Waters Tan & Co.

September 11, 1995

MARK CUNNINGHAM, PLAINTIFF-APPELLANT, CROSS-APPELLEE, JOHN M. STEWART, ET AL., INTERVENING PLAINTIFFS-APPELLANTS, CROSS-APPELLEES,

v.

WATERS TAN & COMPANY, ET AL., DEFENDANTS-APPELLEES, 1211 CORPORATION, FORMERLY KNOWN AS G.H. MILLER & COMPANY, INTERVENING DEFENDANT-CROSS-APPELLANT. JOHN M. STEWART, ET AL., PLAINTIFFS-APPELLANTS, CROSS-APPELLEES, MARK CUNNINGHAM, ET AL., INTERVENING PLAINTIFFS-APPELLANTS, CROSS-APPELLEES,

v.

GNP COMMODITIES, INCORPORATED, ET AL., DEFENDANTS-APPELLEES, 1211 CORPORATION, FORMERLY KNOWN AS G.H. MILLER & COMPANY, INTERVENING DEFENDANT-APPELLEE, CROSS-APPELLANT.



Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. Nos. 88 C 1896 & 91 C 2635--Harry D. Leinenweber, Judge.

Before ESCHBACH, COFFEY and RIPPLE, Circuit Judges.

RIPPLE, Circuit Judge.

ARGUED JANUARY 10, 1995

DECIDED SEPTEMBER 11, 1995

Investors defrauded in a commodity pool scheme sued futures commission merchant G.H. Miller & Co. for recovery of their lost funds. Ruling in two consolidated actions, which we shall refer to as the "Cunningham action" and the "Stewart action," the district court granted summary judgment in each. In the Stewart action, the court granted summary judgment on the ground that the investors could not recover from G.H. Miller because the representative individuals of the putative class did not invest in the pools during the effective date of the G.H. Miller guarantee. In the Cunningham action, the court granted summary judgment on the ground that the individual who perpetrated the fraud did not act within his capacity as an agent for G.H. Miller when conducting the illegal activities. G.H. Miller also moved for Rule 11 sanctions in the Stewart action, submitting that a crucial factual representation in the complaint was false. The district court denied sanctions without explanation. For the reasons set forth in the following opinion, we affirm both of the district court's decisions to grant summary judgment and remand the denial of Rule 11 sanctions for further explanation by the district court.

I. BACKGROUND

A. Facts

In 1982, Dennis K. Tan ("Tan") and partner John Waters ("Waters") started an investment club. The club subsequently began to lose money. Tan and Waters concealed this fact from the club investors by sending them false favorable reports. In 1984, in order to raise more capital, Tan and Waters organized and operated commodity pools. From November 8, 1984 until September 30, 1985, pools were registered with the National Futures Association ("NFA") under the corporate name, "Waters, Tan and Co." ("Waters Tan" or "Waters, Tan & Co.").

In May 1985, Dennis Tan registered with the NFA as an introducing broker for G.H. Miller ("Miller"). Pursuant to federal regulation, *fn1 Mr. Tan entered into a "guarantee agreement" *fn2 with Miller which provided that, in consideration for Tan's introduction of customer accounts to Miller, Miller would guarantee . . . performance by the introducing broker [Dennis Tan] of, and shall be jointly and severally liable for, all obligations of the introducing broker under the Commodity Exchange Act . . . with respect to the solicitation of and transactions involving all customer and option customer accounts the introducing broker entered into on or after the effective date of the agreement.

The agreement was effective from May 18, 1985 until its termination on July 18, 1986. Upon submission of the registration form, Mr. Tan was assigned an NFA registration number different and distinct from the registration number previously assigned to Waters, Tan & Co. as commodity pool operators. Tan never disclosed the existence of the commodity pools to Miller, and, in fact, actively strove to conceal the pools from Miller.

While Tan's guarantee agreement with Miller was effective, Waters Tan used promotional material that falsely stated that Waters Tan, and not Dennis Tan as a sole proprietor, was an introducing broker for Miller. Upon learning of the improper use of the Miller name, a Miller representative immediately warned Mr. Tan to stop portraying Waters Tan as an introducing broker for Miller. He further requested that the material containing the false representation be destroyed. Additionally, in a letter dated March 31, 1986, the NFA censured Tan for representing that Waters Tan, rather than Dennis Tan as a sole proprietor, was the introducing broker guaranteed by Miller.

Mr. Tan, through counsel, stated in April 1986 that the reference to Waters Tan as a guaranteed introducing broker for Miller was a "mistake," would not be repeated, and that all literature with improper references had been destroyed. Soon after, Mr. Tan sought Miller's permission to register Waters, Tan & Co. as an introducing broker. Miller refused. The agreement between Mr. Tan and Miller terminated shortly thereafter. Waters, Tan & Co. ultimately registered as an introducing broker with futures commission merchant GNP Commodities; GNP already has settled the suit brought against it by the plaintiffs.

In March 1988, the CFTC closed the Waters Tan commodity pools on the ground of fraud. The NFA also charged both Tan and Waters, in their personal capacities, with fraud and expelled them. In 1989, Tan was charged, and pled guilty to, criminal racketeering in Arizona.

All of the plaintiffs in this appeal made payments directly to and received certificates from Waters, Tan & Co. None made any payments to Tan individually. None of the trades that form the basis of the allegations in this litigation was placed directly with Miller either through Waters Tan or Tan individually.

B. District Court Proceedings

As noted earlier, this appeal is from two consolidated actions in the district court. *fn3 In March 1988, a commodities fraud class action was filed in the United States District Court for the Northern District of Illinois (Cunningham v. Waters, Tan & Co.). The original Cunningham complaint did not name Miller as a defendant, but rather GNP Commodities, and Tan and Waters individually. In August of 1989, a second class action was filed in federal court in Arizona (Stewart v. GNP Commodities, Inc.). This complaint named Miller as a defendant. Unlike the claims against other defendants who were accused of some sort of fraud or failure to monitor (GNP Commodities, the NFA, Waters and Tan), the only claim against Miller was that of vicarious liability for the fraud of Waters Tan by its deceptive use of the guarantee agreement between Miller and Tan. The Arizona case, Stewart, was transferred to the Northern District of Illinois and was consolidated with Cunningham.

In May 1992, the district court denied class certification. At the same time, the district court granted summary judgment for Miller against the six named plaintiffs in the Stewart action. The district court determined that none of the plaintiffs actually invested in the illegal pools during the term of the Miller-Tan guarantee. Miller also submitted that the Stewart complaint falsely alleged that the six named plaintiffs had invested in pools during the ...


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