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Prestwick Capital Management Ltd. v. Peregrine Financial Group, Inc.

United States Court of Appeals, Seventh Circuit

July 19, 2013

Prestwick Capital Management, Ltd., Prestwick Capital Management 2, Ltd., Prestwick Capital Management 3, Ltd. Plaintiffs-Appellants,
v.
Peregrine Financial Group, Inc., Defendant-Appellee

Argued January 24, 2013

Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 1:10-cv-00023-Elaine E. Bucklo, Judge.

Before Manion and Wood, Circuit Judges, and Barker, District Judge [*]

Barker, District Judge.

Author-cum-rabbi Chaim Potok once observed that life presents "absolutely no guarantee that things will automatically work out to our best advantage."[1] Given the regulatory mandate that certain financial entities guarantee other entities' performance, and acknowledging that guarantees of all sorts can turn out to be ephemeral, we grapple here with the truth of Potok's aphorism. More specifically, the instant lawsuit requires us to clarify the scope of a futures trading "guarantee gone wrong, " presenting sunk investments and semantic distractions along the way.

In 2009, Prestwick Capital Management Ltd., Prestwick Capital Management 2 Ltd., and Prestwick Capital Management 3 Ltd. (collectively, "Prestwick") sued Peregrine Financial Group, Inc. ("PFG"), Acuvest Inc., Acuvest Brokers, LLC, and two of Acuvest's principals (John Caiazzo and Philip Grey), alleging violations of the Commodity Exchange Act ("CEA"), 7 U.S.C. § 1 et seq. Prestwick asserted a commodities fraud claim against all defendants, a breach of fiduciary duty claim against the Acuvest defendants, and a guarantor liability claim against PFG. After the district court awarded summary judgment to PFG in August 2011, Prestwick moved to dismiss the remaining defendants with prejudice in order to pursue its appeal of right against PFG. The district court subsequently dismissed the Acuvest defendants from the lawsuit, rendering its grant of summary judgment a final order which Prestwick now appeals. We affirm the district court.[2]

I. REGULATORY AND STATUTORY BACKGROUND

This commodities fraud lawsuit presents a corporation's attempt to recoup investments allegedly depleted during commerce involving an underfunded trading pool. In this financial setting, parties commonly attempt to shift price risk by signing futures contracts. Briefly stated, a futures contract is an agreement involving a promise to purchase or sell a particular commodity at a fixed date in the future. See Lachmund v. ADM Inv. Servs., Inc., 191 F.3d 777, 786 (7th Cir. 1999). We have previously described the operative promise of such agreements as "fungible" because it employs standard terms and engages clearing brokers to guarantee the parties' respective obligations. Chi. Mercantile Exch. v. S.E.C., 883 F.2d 537, 542 (7th Cir. 1989). "Trading occurs in 'the contract', not in the commodity, " and takes place on the futures exchange, a market meticulously defined and governed by the CEA. Id.

Enacted in 1936, the CEA regulates transactions unique to the futures industry and forbids fraudulent conduct in connection with these activities. When futures trading expanded in the 1970s, Congress " 'overhaul[ed]' the . . . [CEA] in order to institute a more 'comprehensive regulatory structure to oversee the volatile and esoteric futures trading complex.'" Commodity Futures Trading Comm'n v. Schor, 478 U.S. 833, 836 (1986) (quoting H.R. Rep. No. 93-975, 93d Cong., 2d Sess. at 1 (1974)). Congress contemporaneously created the Commodity Futures Trading Commission ("CFTC"), the regulatory agency charged with administering the CEA and promulgating any rules necessary to implement its new structure. Geldermann, Inc. v. Commodity Futures Trading Comm'n, 836 F.2d 310, 312 (7th Cir. 1987) (citing 7 U.S.C. § 12a(5) (1974)). One important aspect of this responsibility is the oversight of futures commission merchants ("FCMs"), which are akin to securities brokerage houses. The CEA defines FCMs as "individual[s], association[s], partnership[s], corporation[s], or trust[s] . . . that [are] engaged in soliciting or in accepting orders for . . . the purchase or sale of a commodity for future delivery." 7 U.S.C. § 1a(28)(A)(i)(I)(aa)(AA).

Prior to 1982, it was customary for FCMs to outsource various projects to independent agents. See S. Rep. No. 97-384, at 40 (1982). The business dealings of these agents—many of whom were individuals or small businesses—troubled the CFTC for many reasons which soon came to the attention of Congress. As the House Committee on Agriculture noted in its May 17, 1982 report on the Futures Trading Act of 1982:

Although agents may perform the same functions as branch officers of [FCMs], agents generally are separately owned and run. [FCMs] frequently disavow any responsibility for sales abuses or other violations committed by these agents. The Committee believes that the best way to protect the public is to create a new and separate registration category for "agents" . . . . Activities of agents and those of commodity trading advisors or associated persons of [FCMs] may be virtually identical, yet commodity trading advisors and such associated persons are registered and regulated under the [CEA], while many agents are not.

H.R. Rep. N o. 97-565(I), at 49 (1982). The CFTC originally suggested requiring "agents" to register as FCMs' "associates, " but Congress rejected that proposal. On that point, the Senate Committee on Agriculture, Nutrition, and Forestry reported, "[I]t would be inappropriate to (1) require these independent business entities to become branch offices of the [FCMs] through which their trades are cleared or (2) to impose vicarious liability on a [FCM] for the actions of an independent entity." S. Rep. No. 97-384, at 41. Yet Congress could no longer avoid the demand "to guarantee accountability and responsible conduct" of entities that "deal with commodity customers and, thus, have the opportunity to engage in abusive sales practices." Id. at 111. This quandary incited new legislation: the Futures Trading Act of 1982, Pub. L. No. 97-444, 96 Stat. 2294 (1983).

One legislative tactic Congress employed to remedy the CEA's perceived shortcomings was to launch a new futures trading entity: the introducing broker ("IB"). Like its "agent" predecessor, the IB was intended to procure customer orders independently, relying on FCMs to retain customer funds and maintain appropriate records. S. Rep. No. 97-384, at 41. This change was discernible in amended § 1a of the CEA, which defines an IB as "any person (except an individual who elects to be and is registered as an associated person of a futures commission merchant) . . . who . . . is engaged in soliciting or in accepting orders for . . . the purchase or sale of any commodity for future delivery." 7 U.S.C. § 1a(31)(A)(i)(I)(aa). To improve IB accountability, the Futures Trading Act of 1982 also supplemented the CEA's registration requirements. The amended CEA provides: "It shall be unlawful for any person to be an [IB] unless such person shall have registered with the [CFTC] as an [IB]." Id. § 6d(g). Registration as an IB is contingent upon the broker's ability to "meet[] such minimum financial requirements as the [CFTC] may by regulation prescribe as necessary to insure his meeting his obligation as a registrant." Id. § 6f(b). In a House Conference Report of December 13, 1982, Congress justified these amendments as follows:

Because many introducing brokers will be small businesses or individuals, as contemplated by the definition of this class of registrant, the conferees contemplate that the [CFTC] will establish financial requirements which will enable this new class of registrant to remain economically viable, although it is intended that fitness tests comparable to those required of associated persons will also be employed. The intent of the conferees is to require commission registration of all persons dealing with the public, but to provide the registrants with substantial flexibility as to the manner and classification of registration.

H.R. Rep. N o. 96-964, at 41 (1982) (Conf. Rep.). Pursuant to 7 U.S.C. § 21(o), the CFTC has delegated this registration function to the National Futures Association ("NFA"), a private corporation registered as a futures association under the CEA. See 7 U.S.C. § 21(j) (discussing requirements for registered futures associations).

In August 1983, the CFTC promulgated a final rule setting forth minimum financial benchmarks for IBs. 48 Fed. Reg. 35, 248, 35, 249 (Aug. 3, 1983). This, too, was a compromise; the draft version of the rule would have required IBs, inter alia, to maintain a minimum adjusted net capital level of $25, 000 and to file monthly financial reports if capital fell to "less than 150 percent of the minimum" amount (the "early warning" requirement). Id. at 35, 249; see also 48 Fed. Reg. 14, 933, 14, 934, 14, 945 (Apr. 6, 1983) (original version of rule). After the notice and comment period, the CFTC reduced the minimum adjusted net capital requirement to $20, 000 and permitted IBs to credit toward this balance 50 percent of guarantee or security deposits maintained with FCMs.[3] 48 Fed. Reg. at 35, 249. The current requisite minimum adjusted net capital is $45, 000 or "[t]he amount of adjusted net capital required by a registered futures association of which [an IB] is a member." 17 C.F.R. § 1.17(a)(1)(iii)(A)-(B). Each IB must annually report its net capital position on CFTC Form 1-FR-IB. Id. § 1.10(b)(2)(ii)(A). However, an IB "shall be deemed to meet the adjusted net capital requirement" if it is a party to a binding guarantee agreement[4] satisfying the conditions outlined in 17 C.F.R. § 1.10(j). Id. § 1.17(a)(2)(ii). A guaranteed IB, in other words, is not subject to the same reporting requirements imposed on an IB that has assumed an independent status. According to the CFTC, this dispensation is appropriate because "the guarantee agreement provides that the FCM . . . will guarantee performance by the [IB] of its obligations under the Act and the rules, regulations, and order thereunder. . . . [and] is an alternative means for an [IB] to satisfy the [CFTC's] standards of financial responsibility." 48 Fed. Reg. at 35, 249.

II. FACTS

In the case before us, the plaintiff, Prestwick, is a conglomerate of Canadian investment companies operating primarily out of Chestermere, Alberta. The defendant, PFG, is an Iowa corporation with its principal place of business in Chicago, Illinois; it also conducts business in New York as an active foreign corporation. Importantly, PFG is registered with the CFTC as an FCM that guarantees compliance with the CEA by certain registered IBs, including two of the Acuvest defendants (Acuvest Inc. and Acuvest Brokers, LLC). Acuvest Inc. is a Delaware corporation with its principal place of business in Temecula, California; Acuvest Brokers, LLC, a branch of Acuvest Inc., is a New York corporation with its principal place of business in the State of New York. Caiazzo and Grey, the remaining Acuvest defendants, are Acuvest Inc. executives who have registered with the NFA in personal capacities.

In 2004, pursuant to the CFTC regulations discussed supra, Acuvest and PFG executed a guarantee agreement ("the 2004 Guarantee Agreement"). See 17 C.F.R. § 1.3(nn). The portion of their 2004 Guarantee Agreement that is the focus of this lawsuit provided, in relevant part, as follows:

PFG guarantees performance by [Acuvest] . . . of, and shall be jointly and severally liable for, all obligations of the IB under the Commodity Exchange Act ("CEA"), as it may be amended from time to time, and the rules, regulations, and orders which have been or may be promulgated thereunder with respect to the solicitation of and transactions involving all commodity customer, option customer, foreign futures customer, and foreign options customer accounts of the IB entered into on or after the effective date of this Agreement.

Thus, the arrangement between PFG and Acuvest contemplated (1) Acuvest's solicitation of customers and subsequent engagement with customers for business dealings, and (2) PFG's willingness to assure Acuvest's customers that Acuvest would conform its conduct to the mandates of the CEA. Further, as the district court noted, this provision made PFG responsible for any fraudulent conduct engaged in by Acuvest.

Two years later, PFG's compliance director, Susan O'Meara, sent a memorandum to the NFA to inform the NFA of a change in PFG's relationship with Acuvest. This correspondence, titled "Guaranteed IB Termination, " was dated August 25, 2006 and advised, "As of August 24, 2006, [PFG] will terminate its guarantee agreement with ...


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