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United States Commodity Futures Trading Commission v. Edward Sarvey and David Sklena

February 10, 2012

UNITED STATES COMMODITY FUTURES TRADING COMMISSION, PLAINTIFF,
v.
EDWARD SARVEY AND DAVID SKLENA,
DEFENDANTS.



The opinion of the court was delivered by: Judge Virginia M. Kendall

MEMORANDUM OPINION AND ORDER

The United States Commodity Futures Trading Commission (CFTC or "Commission") sued defendants Edward Sarvey and David Sklena, two former traders at the Chicago Board of Trade (CBOT), in an enforcement action for violations of Commodity Exchange Act ("the Act") and various CFTC regulations. Specifically, the Commission asserts that on April 2, 2004, right after the government released its monthly jobs report, Sarvey and Sklena executed two illegal and noncompetitive trades of Treasury note futures contracts. According to the CFTC, Sarvey and Sklena arranged a trade between themselves at a below market price, and as a result, Sarvey's clients lost more than $2 million while Sklena netted over $1.6 million. The government indicted both defendants for the same April 2004 trades and Sklena was convicted of wire fraud, commodity fraud and non-competitive trading in November 2010 after a bench trial.*fn1 The CFTC now moves for summary judgment, seeking a permanent injunction banning Sklena from violating the Act, trading as well as an order requiring him to disgorge his profits from the illegal trades and pay three times his gain as a civil monetary penalty under the Act. Sklena, now pro se, did not respond to the motion, and for the following reasons the Court grants the Commission's motion (Doc. 104) in its entirety.

I. MATERIAL UNDISPUTED FACTS

Because Sklena did not respond to the CFTC Local Rule 56.1 statement of material facts, the following facts are deemed admitted, and all citations are to the CFTC 56.1 statement (Doc. 104-1). See L.R. 56.1(b)(3)(C) ("All material facts set forth in the statement required of the moving party will be deemed to be admitted unless controverted by the statement of the opposing party.")

A. Parties and Background

Sklena was a floor broker on the CBOT registered with the Commission between October 1987 until September 2009, when he was suspended by the CFTC pending resolution of his criminal indictment. (¶ 4.) Sklena began trading in the pit for Five Year Note futures beginning in 1991 or 1992. (Id.) A Five-Year Note is a United States Treasury note that matures in five years. The contract unit for trading Five-Year Note futures is $100,000 and is quoted in points, with par on the basis of 100 points. (¶ 1.) In other words, each point equals $1000. (Id.) At the relevant time period in 2004, Sarvey was a dual trader, meaning he executed orders for his customers as well as his own account or accounts he held an interest in. (¶ 3.) When he traded for himself, Sarvey typically traded anywhere from 10 to 500 contracts (or "lots") per transaction. (Id.) At that time, Sklena primarily traded for his personal account. (¶ 6.) Sklena and Sarvey are not strangers: besides working in the same pit, the CBOT brought disciplinary actions against Sklena in 2000 and 2001 for noncompetitive trading with Sarvey, which Sklena settled after accepting a fine and a brief trading suspension. (¶ 5.)*fn2

On the first Friday of every month at 7:30 a.m. Central time, the Bureau of Labor Statistics releases its jobs report for the previous month, which can lead to significant volatility in the futures market. (¶ 2.) On the first Friday of March 2004, a month before the day in question, Sklena lost $320,000 of his own money trading Five-Year Note futures contracts with Sarvey after the February jobs report came out. (¶ 7.) Sklena had insufficient capital to absorb the loss, so his clearing firm had to cover it and Sklena had to repay the clearing firm by selling his CBOT membership. (Id.) Later that month, he had to borrow money from family and take out an additional loan on his house to buy another seat so he could trade. (Id.) The clearing firm warned Sklena to limit his trading going forward because he only had $58,000 in equity in his account. (¶ 8.) As the court that convicted Sklena noted, Sklena told his clearing firm that he would trade only 20 to 50 contracts at a time. (See Doc. 104-4, ¶ 17.)

B. Overview of Sklena and Sarvey's April 2, 2004 Trading

On April 2, 2004, the first Friday of that month, the government released the jobs report for March at the usual time. (¶ 9.) On that day, Sklena and Sarvey were positioned adjacent to each other in the trading pit. (¶ 6.) When the report came out, the price for futures contracts of June 2004 Five-Year Notes dropped sharply for 90 seconds. (¶ 9(a).) Over the next 15 seconds, the price quickly rebounded, though not up to the level it was before the report came out. (¶ 9(b).) During the 90 seconds the price dropped, 2,474 "sell stop"*fn3 orders from Sarvey's customers became "elected," making them immediately executable as market trades. (¶¶10, 12.) In other words, when the orders became elected, Sarvey had an obligation to fill the orders at the best market price. (¶ 12.) Once elected, orders do not become unelected: even though the market quickly rebounded from its low right after the report came out, Sarvey still had to fill his orders at the best possible price. (¶ 12.)

Ninety seconds after the 2,474 contracts became elected, Sarvey asked his clerk how many contracts he need to sell. (¶ 15(a).) At that point, the market price was higher than the price at which he eventually filled the orders. (Id.) About four minutes later, Sarvey sold 2,274 of his contracts to Sklena at an agreed price of 111.065. ¶ 15(b).) That transaction was 45 times larger than the largest trade Sklena told his clearing firm he would make and the price was significantly lower than the market price at the time of the sale, which was somewhere between 112.010 and 112.025. (Id.)*fn4 Just

seconds later, Sklena sold 485 of the 2,274 contracts back to Sarvey for his personal account at 111.070, a price higher than Sklena had just paid but still lower than the prevailing market price at the time, leaving Sklena with 1,789 contracts and Sarvey with 485 contracts. (¶ 15(c).) To offset their below-market purchases, Sklena and Sarvey immediately sold those contracts back into the market at the higher prevailing prices. (¶ 15(d).) In short, Sklena compensated Sarvey for the low-price contracts by selling them back to Sarvey at a below market price, knowing that they could both offset the low-priced contracts in the rallying market and make money. (¶ 17.) Sklena and Sarvey profited $1,652,187.50 and $357,250, respectively, on the trades. (¶ 18.) However, because Sarvey's customers' orders were filled at a non-competitive price near when the prevailing market was trading considerably higher, his customers were disadvantaged to the tune of $2,048,781. (Id.)

C. Evidence of Sklena Aiding and Abetting the Scheme

Digging deeper into the events of that the morning, the Commission presents the following details about the trades to demonstrate that Sklena actively aided and abetted the scheme. First, based on their history of trading together since 2000, Sklena knew that Sarvey was selling customer contracts- not trading on his own account-when he sold the 2,274 contracts. (¶ 16.) Sklena also knew, based on his experience as a broker and handling Sarvey's orders as his backup broker, that Sarvey was obligated to fill his customers' sell orders at the best available price in the prevailing market. (Id.) Based on recordings of the headset conversations between Sarvey's assistant and clerk, Sarvey and Sklena did not discuss a trade when the market price was 111.065, the eventual trading price. (¶ 20.) It was not until 90 seconds after that price, when the market had rallied and the price increased, that Sarvey's clerk started to figure out how many contracts Sarvey needed to sell. (¶ 21.) About two minutes later, when Sarvey asked his clerk what his lowest sell stop order was, the market had been above 111.065 for four minutes. (¶ 23.) Sarvey knew what the market price was - he was in the pit and trading on the CBOT's electronic exchange and must have known the prevailing prices. (Id.) Almost six minutes after 111.065 was an active price, and when the prevailing price was over 112 as noted above, Sarvey's clerk confirmed a price of 111.065 for the contracts. (¶ 22.)

One second after Sarvey sold 2,274 contracts to Sklena, Skelena, acting against his economic interest, sold 485 contracts back to Sarvey at a below market price; Skelena could have made much more selling the contracts to someone else at the prevailing price. (¶ 24.) Immediately after he bought the 2,274 contracts from Sarvey in the pit, Skelena reset his computer from 25-lot sales to 50-lot sales and started selling them off on the CBOT's electronic exchange. (¶ 24.) Sklena also recorded the trade with ...


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