Opinion
01 Civ. 11602 (RWS).
October 17, 2002
LACHER LOVELL-TAYLOR, Attorney for Plaintiff, New York, NY, By: MICHAEL A. LACHER, ESQ., ADAM J. RADER, ESQ., Of Counsel.
CADWALADER, WICKERSHAM TAFT, Attorney for NYBOT Defendants, New York, NY, By: HOWARD R. HAWKINS, JR., ESQ., CHRISTINE P. JACKSON, ESQ., Of Counsel.
OPINION
Defendants Board of Trade of the City of New York, Inc. ("NYBOT"), New York Futures Exchange, Inc. ("NYFE"), New York Clearing Corporation ("NYCC"), and the New York Futures Exchange Settlement Committee and its members except for Norman Eisler (the "Committee") (collectively, the "NYBOT Defendants") moved pursuant to Fed.R.Civ.P. 12(b)(6), to dismiss the first, second, and third claims of the complaint of plaintiff DGM Investments, Inc. ("DGM") as against the NYBOT Defendants for failure to state a claim upon which relief can be granted, pursuant to Fed.R.Civ.P. 9(b), to dismiss the third claim of the complaint as against the NYBOT Defendants, pursuant to Fed.R.Civ.P. 12(b)(1) and 28 U.S.C. § 1332 and 1367, to dismiss the fourth and fifth claims of the complaint as against the NYBOT Defendants for lack of subject matter jurisdiction, and to dismiss the fourth and fifth claims of the complaint pursuant to Fed.R.Civ.P. 12(b)(6) for failure to state a claim upon which relief can be granted. For the reasons set forth below, the motions are granted.
Prior Proceedings
The Complaint
On December 19, 2001, DGM filed its complaint against the NYBOT Defendants. The complaint alleges DGM is a Nevada corporation that "operated a fund" that engaged in commodity transactions. Compl. ¶ 3, that NYBOT is a New York not-for-profit corporation. id. ¶ 5, and is the ultimate parent company of NYCC and defendant NYFE, see id. ¶ 11. NYFE, a New York corporation, is a futures and options exchange designated by the U.S. Commodity Futures Trading Commission (the "CFTC") as a contract market for the trading of various commodity futures and options, including the Pacific Stock Exchange Technology Index Futures Contracts and Options ("P-Tech Futures and Options"). Compl. ¶¶ 4, 21. The P-Tech Futures and Options were based on a composite index of 100 technology stocks compiled by the Pacific Stock Exchange. Compl. ¶ 21.
The Committee is alleged to have consisted of three members during the relevant time period: Norman Eisler, Joe Jach and Walter Fair, Compl. ¶ 6, who were responsible for calculating settlement prices for P-Tech Futures and Options. Id. Defendant NYCC, a New York corporation, is the designated clearing-house of NYBOT's exchange markets, including the NYFE. Id. ¶¶ 4, 7.
The complaint is said by the NYBOT Defendants to refer to Mr. Jach as "Jack."
Norman Eisler ("Eisler") was registered with the CFTC as a floor broker from in or about April 1993, id. ¶ 10, and prior to May 15, 2000, was the chairman of the board of directors of NYFE and chairman of the NYFE settlement committee for P-Tech Futures and Options. Id. ¶¶ 6, 10. It is also alleged that he controlled various brokerage accounts which were subject to margin calls, and from on or about April 1996 through May 15, 2000, purchased and sold P-Tech Futures and Options for his own account. Id. ¶¶ 10, 26, 35.
According to the complaint, it is alleged that during the period Eisler was trading in P-Tech Futures and Options, he was responsible for miscalculations of the daily closing or "settlement price" of P-Tech Futures and Options, id. ¶¶ 10, 13-14, 27, which prices are used by clearing houses to calculate the amount of daily variation margin to be paid to or received from the clearing houses, calculated to be the difference between the settlement price and the trade price, or (for a held position) the previous day's settlement price. Id. ¶ 22. DGM alleges that Eisler miscalculated the settlement prices between August 1999 and May 2000, id. ¶¶ 10, 13, and that as a result accounts controlled by him and others "avoided margin calls and increased their own liquidity." Id. ¶ 13, and that the fixing of artificial settlement prices by Eisler and overstatement of the value of Eisler's account thereby distorted the P-Tech market, causing the clearing houses to charge incorrect margins and understate DGM's accounts. Id. ¶¶ 13-14, 27.
The complaint alleges that on or about April 10, 2000, DGM's clearing broker advised DGM of a margin call on its accounts in the amount of $967,480, id. ¶ 15, that DGM allegedly met this margin call, as well as another of which it was advised on or about April 12, 2000, in the amount of $433,521, id., and that DGM allegedly was unable to meet a third margin call in the amount of $3,500,000 on or about April 14, 2000. Id. DGM alleges that as a result of these improper margin calls, it lost its capital and was forced to wind up its affairs. Id.
DGM alleges that the NYBOT Defendants failed to discover the mispricing and take corrective action. Id. ¶¶ 19. Specifically, the complaint alleges that the NYBOT Defendants failed to enforce NYFE Rule 315 adequately, which regulates determination of settlement prices. Id. ¶¶ 33-40.
The complaint alleges that defendants violated various provisions of the CEA and regulations issued thereunder. DGM also asserts common law claims of gross negligence and bad faith, and respondeat superior liability. Id. ¶¶ 41-71.
The complaint alleges that this Court has jurisdiction over the federal claims pursuant to 28 U.S.C. § 1331. Id. The complaint also alleges that this Court has diversity jurisdiction pursuant to 28 U.S.C. § 1332 because the matter in dispute exceeds the value of $75,000 and "is between citizens of different States." Id. The complaint also alleges supplemental jurisdiction over the common law claims, id. ¶ 1, and seeks $25 million in compensatory damages and $150 million in punitive damages. See id. ¶¶ 16, 20, 46, 52, 60, 65-66, 70-71.
The instant motions to dismiss the complaint were heard and marked fully submitted on May 15, 2002.
Bad Faith Has Not Been Adequately Alleged
The NYBOT Defendants have moved to dismiss the first three causes of action based upon the failure of DGM to allege bad faith adequately. Section 25(b) of Title 7 provides in subsection 4 that:
a person seeking to enforce liability under this section must establish that the contract market, licensed board of trade, clearing organization, registered futures association, officer, director, governor, committee member, or employee acted in bad faith in failing to take action or in taking such action as was then taken, and that such failure or action caused the loss.
The complaint alleges a bad faith cover-up of the manipulation by the NYBOT Defendants and a "bad faith failure to take any action to correct the price manipulation of which they were aware." Compl. ¶ 19. The complaint also alleges that NYFE failed to enforce its own rules concerning procedures relating to the regulation of settlement prices, specifically NYFE Rule 315, and that "upon information and belief, NYFE received or became aware of complaints about the distortion of settlement prices and still did not take any action to put a procedure in place" to assure compliance with NYFE rules. Compl. ¶ 37. The complaint alleges that the NYBOT Defendants knowingly and intentionally failed to enforce the market rules. Compl. ¶¶ 19, 37.
The complaint also alleges that exposure of the price manipulation to the CFTC and to the members and customers of NYFE would have adversely effected the market and might cause the individual board members to be sanctioned, censured or lose their jobs. Compl. ¶¶ 19, 30, 44, 51.
Bad faith has been defined by the Honorable Alan K. Hellerstein, Western Capital Design LLC v. New York Mercantile Exch., 180 F. Supp.2d 438, 442-43 (S.D.N.Y. 2001), aff'd, No. 01-7348, 2002 WL 10253 (2d Cir. Jan. 3, 2002), in the following terms:
Bad faith requires wrongful knowledge, and failure to act on that knowledge with a motive ascribable to malfeasance. "[S]elf-interest or other ulterior motive unrelated to proper regulatory concerns must constitute the sole or dominant reason for the exchange action or inaction." Minpeco, S.A. v. Hunt, 693 F. Supp. 58, 61 (S.D.N.Y. 1988) (citation omitted). "[T]o succeed on a claim of bad faith, plaintiffs must establish `first, that the exchange acted or failed to act with knowledge and second, that the exchange's action or inaction was the result of an ulterior motive.'" Id. (quoting Ryder Energy, 748 F.2d at 780). Although irrational or arbitrary behavior in some circumstances may support an inference of bad faith, the behavior has to be "so arbitrary" as to justify an inference of "constructive bad faith." See Minpeco, 693 F. Supp. at 63; see also Brawer v. Options Clearing Corp., 807 F.2d 297, 303 n. 9 (2d Cir. 1986) ("We do not mean to foreclose the possibility that [exchange actions] might be so arbitrary as to constitute constructive bad faith."), cert. denied, 484 U.S. 819, 108 S.Ct. 76, 98 L.Ed.2d 39 (1987); Jordon v. New York Mercantile Exchange, 571 F. Supp. 1530, 1553 (S.D.N.Y. 1983), affirmed in relevant part, Sam Wong, 735 F.2d 653 (2d Cir. 1984).
The line sought to be drawn by the authorities and the statute is that between negligence and inaction and action that an "ulterior motive" meaning according to the Random House Dictionary of the English Language, Library of Congress Catalog Card Number 74-129325:
1. being beyond what is seen or avowed: intentionally kept concealed: ulterior motives
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3. lying beyond or outside of some specified or understood boundary: more remote: a suggestion ulterior to the purposes of the present discussion.
In the present context, bad faith must constitute an intent to commit an act, or fail to do an act, for some reason outside of the recognized performance of the office. Here there is no allegation of personal profiting, bribery or payoff, or secret motive outside the parameters of the duties imposed upon the NYBOT Defendants. The allegation here in the complaint is that the NYBOT Defendants knew of manipulation and their motivation for inaction was to preserve the organizations and their positions. Those allegations here do not rise to the level of arbitrary or irrational behavior sufficient to support an inference of bad faith. The inference of negligent inattention is equally compelling.
This conclusion is consistent with the decision of the Honorable Richard Conway Casey in Vitanza v. Board of Trade of New York, Inc., No. 00 Civ. 7393 (RCC), 2002 WL 424699 (S.D.N.Y. Mar. 18, 2002), which involved the same scheme alleged in this action.
The claims brought under 7 U.S.C.A. § 25 must be dismissed.
DGM Lacks Standing
DGM according to the complaint "operated a fund which among other things bought and sold PSE Technology Index (`P-Tech'), Futures Options contracts and traded on and pursuant to the rules of the New York Futures Exchange, Inc. (`NYFE')." Compl. ¶ 3. There is no allegation that DGM bought or sold on the exchange.
Section 725 grants damages to "a person that engaged in any transaction specified in subsection (e)," which in turn speaks of purchases and sales. Under the statute it appears that only a purchaser or seller has a right of action, in other words, the fund, not the corporation DGM that operates the fund.
The Seventh Circuit has reached a similar conclusion in an action brought under the statute by a national organization representing farmers in American Agriculture Movement, Inc. v. Board of Trade of Chicago, 977 F.2d 1147 (7th Cir. 1992):
By its terms, then, § 22(b) creates the exclusive remedies available to those injured by violations of the CEA, and makes those remedies available only to persons injured in the course of trading on a contract market. It therefore forecloses all other remedies, including any on behalf of non-traders. To the extent (if any) that pre-1974 courts had implied private remedies against exchanges in favor of non-traders, Congress directed them to stop doing so in § 22(b).
Id. at 1153.
The State Law Claims Are Preempted
The statute under which DGM has brought its first three claims preempts the fourth and fifth state law claims for gross negligence and bad faith and respondeat superior. The CEA established a comprehensive federal regulatory scheme to govern the conduct of contract markets and their participants — a scheme to be administered and enforced by the CFTC. "Congress' intent to bring the markets under a uniform set of regulations" followed from a fear that states might attempt to regulate futures markets themselves and thus "subject the national futures trading apparatus to conflicting regulatory demands." American Agriculture Movement, 977 F.2d at 1155-56. In American Agriculture Movement, the Seventh Circuit considered the history and purpose of the CEA, and determined that in circumstances such as those presented here, claims based on state law challenging the operations of contract markets were preempted by Congress' enactment of the CEA.
In ruling that the state law claims for breach of fiduciary duty and negligence were preempted by the CEA, the Seventh Circuit reviewed the legislative history and purposes behind the CEA. Id. at 1153-57. From the legislative history of the Commodity Futures Trading Commission Act of 1974, 88 Stat. 1389 (the "1974 Act", which created the CFTC and granted it broad powers to enforce the CEA), the Seventh Circuit determined that the legislators "were concerned that the states . . . might step in to regulate the futures markets themselves. This, they feared, might have subjected the national futures trading apparatus to conflicting regulatory demands." Id. at 1156 (citations omitted). The CEA, as amended by the 1974 Act, prevented this result by placing "`all exchanges and all persons in the industry under the same set of rules and regulations for the protection of all concerned.'" Id. (quoting H.R. Rep. No. 93-975, at 76 (1974)).
Based on this legislative history, the Seventh Circuit concluded that allowing plaintiffs to pursue state law claims challenging official exchange action would frustrate Congress' intent to bring the markets under uniform federal regulations. Id. The Seventh Circuit recognized that some other courts had held certain state law claims not preempted by the CEA, but harmonized the decisions as follows:
The punitive damages claimed by plaintiff in connection with its state law claims is one example. See Compl. ¶¶ 66, 71. CEA § 22 expressly limits the damages available in an action brought under the CEA to "actual losses" caused by a violation of the CEA and does not allow for punitive damages. 7 U.S.C. § 25(b)(1)-(3). It is not difficult to see how it would upset the uniform federal regulatory scheme to subject contract markets to differing state prescriptions for damages that depart so starkly from federal law.
[Those] cases are distinguishable from the case before us on one critical ground: they have little or no bearing upon the actual operation of the commodity futures markets. Only in the context of market regulation does the need arise for uniform legal rules. As Congress recognized in enacting the 1974 Act, a contract market could not operate efficiently, and perhaps not at all, if varying and potentially contradictory legal standards governed its duties to investors . . . .
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In sum, the structure and history of the CEA indicate that the propriety of conflict preemption depends upon the particular context in which a plaintiff seeks to bring a state law action. When application of state law would directly affect trading on or the operation of a futures market, it would stand "as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress," and hence is preempted.
Id. at 1155, 1156 (citations omitted). See also Barbara v. New York Stock Exch., Inc., 99 F.3d 49, 59 (2d Cir. 1996) (adopting reasoning of American Agriculture Movement in securities context).
Just like the state law claims alleged by plaintiffs in American Agriculture Movement, both of the state law claims alleged by plaintiff here would directly affect "trading on or the operation of a futures market." DGM's fourth claim, for gross negligence, is comparable to the negligence claim brought in American Agriculture Movement, 977 F.2d at 1153-54. DGM's fifth claim, for its part, is a statement of vicarious responsibility that seeks to connect DGM's previous allegations against some defendants to other defendants. Compl. ¶ 68. Both claims depend on allegations that the NYFE, NYCC, NYBOT, and their directors, officers, committee members, and employees failed to fulfill their obligation to regulate the market in P-Tech Futures and Options.
These are matters for uniform federal regulation subject to review by the CFTC, not matters for review or adjudication by individual state courts. For the reasons set forth in American Agriculture Movement, these state law claims are preempted by the CEA and should be dismissed with prejudice as against the NYBOT Defendants pursuant to Fed.R.Civ.P. 12(b)(6). See also Western Capital, 180 F. Supp.2d at 442-43 (S.D.N.Y 2001).
For the reasons set forth herein, the motion of the NYBOT Defendants is granted with leave granted to DGM to replead within twenty (20) days.
Settle order.
It is so ordered.