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SELIGSON v. NEW YORK PRODUCE EXCH.

May 17, 1974

Charles SELIGSON, as Trustee in Bankruptcy of Ira Haupt & Co., a Limited Partnership, Bankrupt, Plaintiff,
v.
NEW YORK PRODUCE EXCHANGE et al., Defendants


Robert L. Carter, District Judge.


The opinion of the court was delivered by: CARTER

ROBERT L. CARTER, District Judge.

Explanatory Statement

 This case arises out of what has come to be known as the "Salad Oil Swindle", one of the most notorious commercial and financial disasters in American history. The swindle resulted in losses to various exporters, brokers, warehousemen, financial institutions, and insurers in excess of $100 million, and led to a string of lawsuits and investigations extending over the past ten years. The roster of persons and institutions adversely affected by master swindler Anthony DeAngelis, working through controlled corporations like Allied Crude Vegetable Oil Refining Corporation (Allied), *fn1" is long and impressive, and includes not only the parties to this litigation, but also such august institutions as the American Express Company and the Chase Manhattan Bank.

 To capture the swindle in all its glory would take a book. Fortunately, it has already been written. See N. Miller, The Great Salad Oil Swindle, (1965). The instant action, however, as framed by defendants' motions for summary judgment, involves a rather discrete series of events, revolving around the activities of Allied's principal commodities broker, Ira Haupt & Co. (Haupt) in cottonseed oil futures trading on the New York Produce Exchange (the "Exchange"). Accordingly, a few words about the Exchange and how it functions are in order.

 The Cottonseed Oil Futures Market

 The New York Produce Exchange is a formal, self-regulated, contract market, similar in concept to a securities exchange, and on it contracts *fn2" for the purchase and sale of commodities to be delivered on specified dates in the future, "futures" for short, are traded. *fn3" The principal terms of these futures, other than price, are prescribed by the Exchange. *fn4"

 Futures trading should be distinguished from ordinary commercial, or "cash" trading. In a cash transaction, whether for present or future delivery, the purchase price usually is paid in its entirety when the transaction is effected, and the oil bargained for is consumed, exported, or otherwise disposed of by the purchaser. Futures, on the other hand, are purchased through a clearing house, here the New York Produce Exchange Clearing Association ("Clearing Association" or "Association") by putting up a fixed percentage of the purchase price as "original margin," and by putting up such additional "variation margin" during the day as the Manager deems necessary "to protect the Association against fluctuations in the market, pending the daily settlement."

 Futures normally are not used to effect delivery -- most are liquidated prior to the delivery date -- but instead are used by farmers, processors, exporters, and others who deal in a commodity as a means of "hedging" their commodity positions and "cash" commodity obligations against unanticipated fluctuations in price. A trader who, as a result of normal business dealings, has accumulated or is obligated to buy a large quantity of cash cottonseed oil (and is therefore, "long" in cash oil), can hedge his bets by taking a futures position opposite to his cash position, i.e., he can go "short" and become the seller in an equivalent volume of futures contracts. Thereafter, if the price of oil declines, although the value of the trader's accumulated oil likewise declines, his loss is offset by the fact that he has entered into futures contracts to sell oil at predecline price levels. Futures may also be traded for purely speculative purposes so long as special original margin requirements are met.

 A futures contract is "cleared" through the Clearing Association when the Association "accepts" the contract, thereby assuming the obligations and succeeding to the rights and benefits under the contract of both parties to it. In turn, the clearing members who present a futures contract for clearance engage that they will, in response to a daily report prepared by the Association, deliver to the Association a check made to its order or a draft made to the member's order and drawn on the Association, and that the check or draft will include the amount (fixed in the report) necessary to "mark contracts to the settlement price." Thus, each business day each clearing member pays to or receives from the Association a sum equal to the difference between the value of its futures at the last posted settlement price, and their value at the next previous settlement price.

 Background Facts

 During the latter part of 1963, Haupt and other brokers acquired on behalf of Allied a very substantial long position in cottonseed oil futures. By November 14, 1963, Allied was the buyer in approximately 90% of the futures contracts traded on the Exchange. On that day Berg, the Managing Director of the Exchange, received from the Commodity Exchange Authority (CEA) *fn5" a statement of the positions of persons or companies with futures positions in excess of 100 contracts. Berg thereupon indicated the magnitude of Allied's holdings to defendants Anderson and MacDonald, and MacDonald in his capacity as President of the Exchange immediately called a meeting of the Board of Managers for that afternoon. At that meeting a Control Committee was appointed, and directed and empowered to determine the precise nature and dimensions of Allied's position.

 A concentration in the long interest like that achieved by Allied is fraught with potential danger to the market, inasmuch as it reduces liquidity, lessens price stability, heightens the risk of a disorderly liquidation of contracts should the demand curve faced by the party holding the interest shift, and in general threatens the maintenance of an orderly market. At the same time, a concentrated long position leaves the person who accumulates it exceedingly vulnerable to declines in the market. And decline the market did, sharply between November 14 and November 19, 1963. During that period Haupt was called upon by the Clearing Association to put up variation margin, and in turn Haupt called upon Allied for reimbursement. By November 19, Allied was unable to respond to Haupt's margin calls, and filed a petition under Chapter XI of the Bankruptcy Act.

 Later that day, at a joint meeting of the Exchange's Executive Committee and the Association's Board of Directors, Allied's plight was revealed. Also disclosed was the fact that of the 10,273 futures contracts in which Allied was the buyer, 8,043 were held for it by Haupt. Those present were advised by representatives of Haupt that it would be unable to meet its margin requirements should the market continue to drop. After considerable discussion, and telephonic or personal consultation with approximately two-thirds of the Exchange's Board of Managers, the Executive Committee decided unanimously to recommend to the Exchange Board that trading in cottonseed oil futures be suspended until further notice, and that settlement prices be fixed. On November 20, the Exchange did not reopen, and the Board of Managers formally ratified the decision reached the previous day.

 On or about November 22, 1963, Haupt discovered that warehouse receipts, which it received from Allied as collateral for the variation margin it put up during the November 14-19 market decline, were worthless. The receipts were forged, and the salad oil, the presence of which the receipts purported to authenticate, was non-existent. On March 23, 1964, an involuntary petition in bankruptcy was filed against Haupt.

 Plaintiff's Claims

 Plaintiff is the trustee in bankruptcy of Ira Haupt & Co. Defendants include the Exchange; the Association; individuals who were employed by or served on the Board of Managers of the Exchange; the President and the Manager of the Association; and certain firms with which the individual defendants were associated in November, 1963. *fn6" All of the defendants are named in Counts One and Two of the Amended Complaint. Count Three names only the Association and the Exchange.

 Count One of the Amended Complaint alleges that defendants are charged by the Act with maintaining an orderly market; preventing undue and undesirable speculative activity; preventing the manipulation of prices and cornering of the market; and operating the Exchange and the Clearing Association in a just, equitable, fair and honest manner. In derogation of these duties, defendants during 1963 and until November 14th failed to act even though they knew or should have known the nature and extent of Allied's position in cottonseed oil futures; that Allied's accumulation artificially affected prices and threatened maintenance of an orderly market; that they were required in the proper exercise of their regulatory duties to eliminate the threat posed by extreme market concentration, or at the very least were required to investigate in order to establish that no real threat existed.

 Plaintiff further alleges that between November 14, 1963 and November 20, 1963, defendants knew that immediate action was needed in order to preserve an orderly market, and that trading should be suspended. However, the market was kept open solely so that prices could decline to the benefit of the "short interests" and to the detriment of the "long interests", principally Allied. This decision constituted bad faith regulation, and resulted in a loss to Haupt of $12,000,000, which amount of variation margin it paid to the Association during that period.

 On November 20th, contends the plaintiff, it became apparent to defendants that should the market continue to decline, clearing members other than Haupt would have to assume the financial burden of additional margin calls, and of the liquidation of Allied's position in the open market. Therefore, trading was suspended on the 20th in bad faith in order to protect defendants' interests.

 The circumstances that gave rise to Count One also underlie Count Two, which alleges that beginning on or about the Summer of 1963 and continuing until at least November 20, 1963, defendants engaged in a combination and conspiracy in unreasonable restraint of trade in violation of Section 1 of the Sherman Act, 15 U.S.C. § 1, by combining, conspiring, and agreeing among themselves to, inter alia, abdicate their statutory duties and obligations, control and fix prices of futures contracts from and after November 14, 1963, and permit some among them to profit from their loss. The gravamen of Count Two is that defendants' alleged improper motivation and bad faith in the exercise of their regulatory responsibilities renders their acts and omissions an unreasonable restraint of trade.

 Count Three alleges that the Association and the Exchange are fraudulent transferees under New York State law, because the $12 million paid by Haupt to the association in variation margin between November 14, 1963 and November 20, 1963 was transferred without fair consideration at a time when Haupt was insolvent.

 Defendants now move for summary judgment on all three counts.

 COUNT ONE

 Existence of a Cause of Action

 Defendants question whether the Act supports a cause of action by a member of an Exchange (or its trustee in bankruptcy) against the Exchange and its officers based on an alleged failure to regulate that member's own wrongful conduct. There are two aspects to defendant's challenge: whether an Exchange member-broker (as contrasted with a member-trader or the customer of a member) is entitled to bring suit; whether Haupt's own misconduct disentitles it from bringing the action.

 In Deaktor v. L. D. Schreiber & Co., 479 F.2d 529 (7th Cir.) rev'd on other grounds, 414 U.S. 113, 94 S. Ct. 466, 38 L. Ed. 2d 344 (1973), two actions were consolidated, one brought on behalf of a class of short traders against the Chicago Mercantile Exchange (C.M.E.) and various members of the C.M.E., the other brought by twenty-four traders against the C.M.E., and against certain of its officers and members. The class plaintiff alleged that C.M.E. members manipulated and cornered the July, 1970 frozen pork bellies futures market, and that the C.M.E. failed to be aware of and halt promptly this unlawful activity. The individual plaintiffs charged the defendants with monopolization of trading in March, 1970 fresh eggs futures.

 
"There remains the question whether private damage actions are allowable under the Commodity Exchange Act. As noted earlier, no express provision is contained in the Act. The courts which have considered the question, however, have apparently uniformly concluded that such an action exists.
 
. . .
 
"It is a felony under 7 U.S.C. § 13(b) of the Act to manipulate or attempt to manipulate the price of any commodity or to corner or attempt to corner any such commodity. We think the enactment is at least in part intended to protect the interests of the plaintiff-traders in these actions. We therefore hold that a private cause of action exists under the Commodity Exchange Act in favor of the plaintiffs in these actions . . ." Id, at 534.

 Defendants suggest that this cause of action should not be available to Exchange member-brokers. However, brokers as well as customers suffer when an orderly market is not maintained. Notwithstanding the fact that Haupt's bankruptcy might have been caused by extra-market forces (viz. the fact that Haupt accepted forged warehouse receipts from Allied as security), the losses which Haupt seeks to recover here are directly related to the sharp plunge taken by the cottonseed oil futures market in November, 1963. Assuming, arguendo, that this market behavior was the result of defendants' malfeasance or nonfeasance, plaintiff has as great a right to be protected by maintaining this action as would a customer who held a long position on November 14th.

 This conclusion is reinforced by the fact that private lawsuits, in addition to redressing injuries suffered by particular plaintiffs, play a role in fulfilling the Congressional purpose of insuring the maintenance of orderly markets. Cf. Pearlstein v. Scudder & German, 429 F.2d 1136, 1141 (2d Cir. 1970). Moreover, the House Report accompanying the Act indicates that Congress was conscious that the Act's imposition of duties and responsibilities operates to protect the interests of exchanges themselves, hence of their members:

 
"The fundamental purpose of the measure is to insure fair practice and honest dealing on the commodity exchanges and to provide a measure of control over those forms of speculative activity which too often demoralize the markets to the injury of producers and consumers and the exchanges themselves." H.R.Rep.No. 421, p. 1, 74th Cong., 1st Sess. (1935).

 Neither the Exchange nor its employees and board members deny that they are required both by the Act and by Exchange By-laws to preserve an orderly market and prevent manipulation and cornering. However, defendants Bunge and Klein contend that an "abuse of discretion" standard should be applied to good faith actions taken by the Exchange in enforcing its rules. This contention has little relevance to so much of plaintiff's claim as alleges bad faith regulation. However, it does strike at that part of the complaint which alleges negligent failure to discover, investigate or act.

 The duties imposed by § 7(d) of the Act and the corresponding portions of §§ 67 and 68 of the Exchange By laws are broadly scriped. When viewed in the context of a market the behavior of which is a function of the interrelation of many factors, not all of them precisely or instantaneously knowable or measurable, these provisions suggest that a significant amount of discretion is reposed in the Exchange in respect of the manner in which its statutory duties are to be complied with in any given set of circumstances. Thus, although a cause of action exists for negligent failure to regulate, see Baird v. Franklin, 141 F.2d 238 (2d Cir.) cert. denied, 323 U.S. 737, 65 S. Ct. 38, 89 L. Ed. 591 (1944); Pettit v. American Stock Exchange, 217 F. Supp. 21 (S.D.N.Y.1963), defendants' caution is well taken. However, defendants' refinement of Baird and Pettit does not, on the record before me alter whether there exist genuine issues of material fact in respect of defendants' alleged nonfeasance.

 Defendants' contention that plaintiff cannot recover here because of Haupt's own misconduct has two basic thrusts: the defendants' alleged failure to fulfill their statutory obligations was not a "proximate cause" of Haupt's losses; defendants are entitled to assert the defense of in pari delicto. Obviously liability will not ensue unless a tortious act is a substantial factor, as well as an actual factor, in bringing about resultant harm. See Restatement, Second, Torts §§ 430-433. Defendants insist that any act they may have committed or omitted was robbed of this characteristic by an intervening or supervening cause; namely, the fact that the warehouse receipts which Haupt accepted from Allied proved to be worthless.

 This argument assumes that defendants are entitled to benefit from an obligation (by Allied to reimburse Haupt) that ran only to Haupt, and not to any of the defendants. Moreover, the argument assumes that the losses Haupt seeks to recover stemmed from Haupt's insolvency. On the contrary, the complaint indicates clearly that the losses here claimed, $12,000,000, resulted from variation margin in that amount which Haupt paid to the Association between November 14 and November 19, 1963. Presumably, even had Haupt remained solvent following the salad oil swindle, it could have brought the instant action.

 Even if Haupt's insolvency were inextricably bound up in the losses here claimed, and even if Haupt's acceptance of worthless warehouse receipts is viewed as an event which occurred at the time their worthlessness was discovered rather than contemporaneously with their delivery, acceptance of the receipts would not break a chain of causation unless it "is so unexpected that the injury is not to be a reasonably foreseeable result of the first act." Ingham v. Eastern Air Lines, Inc., 373 F.2d 227, fn 11 (2d Cir.) cert. denied sub nom. United States v. Ingham, 389 U.S. 931, 88 S. Ct. 295, 19 L. Ed. 2d 292 (1967). There are sufficient admissions by defendants in the record from which one might reasonably infer that in November, 1963, defendants knew enough about De-Angelis' past business dealings to be suspicious of warehouse receipts tendered by him. Thus, there exists at least a genuine issue of material fact in respect of whether the worthlessness of the receipts was foreseeable to defendants.

 Certain of the defendants urge that if they violated their regulatory duties under the Act, Haupt, as a member of the Exchange and subject to the Act, was, at a minimum, in pari delicto. And since this defense could have been raised against the bankrupt, it can be raised against the trustee who stands in its shoes. Relying on Buttrey v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 410 F.2d 135 (7th Cir.) cert. denied, 396 U.S. 838, 90 S. Ct. 98, 24 L. Ed. 2d 88 (1969), plaintiff contends that he is not subject to defenses to Count One which defendants could have asserted against Haupt. Here, however, in Counts One and Two, the trustee appears to be proceeding under §§ 70(a)(5) and 70(a)(6) of the Bankruptcy Act, rather than the "strong arm" provision utilized in Buttrey, § 70(e), and is therefore subject to the same defenses as would the bankrupt. 4A Collier on Bankruptcy § 70.28, p. 385 (14th Ed. 1971).

 The doctrine of in pari delicto is not applicable to this case, given circumstances as they presently appear. In Nathanson v. Weis, Voisin, Cannon, Inc., 325 F. Supp. 50 (S.D.N.Y.1971), Judge Weinfeld outlined the considerations which caused him to reject the defense of in pari delicto :

 
"The basic question, as this court views it, centers not about the claims asserted by plaintiffs against the defendant or the defense advanced in resistance to those claims, but rather about third parties not involved in the litigation -- the investing public and what policy with respect to the allowance or disallowance of the defense would best serve to carry out the prime purpose of the securities laws to protect the investing public. (At pp. 52-53).

 And in Pearlstein v. Scudder & German, supra, the court stated that:

 
"In our view the danger of permitting a windfall to an unscrupulous investor is outweighted by the salutary policing effect which the threat of private suits for compensatory damages can have upon brokers and dealers above and beyond the threats of governmental action by the Securities and Exchange Commission." (At p. 1141).

 In Pettit v. American Stock Exchange, supra, the trustee-in-reorganization of a company was permitted to bring suit against the American Stock Exchange for its failure to stop the fraudulent activities of Exchange specialists, notwithstanding the fact that the company's president and controlling person conspired with the specialists.

 
"The Exchange argues, as it did in the case of the first count, that the statute is designed solely to protect investors and therefore cannot be utilized to vindicate rights of the corporation that stem primarily from mismanagement of insiders. As in the case of Section 10(b), however, the statutory scheme should not be so restricted where, as here, the loss to the corporation arises from a fraudulent transaction in its securities which is successfully perpetrated through the conduct of the Exchange." (at p. 29).

 The regulatory scheme established by the Commodity Exchange Act likewise is designed to protect investors and to police those who work in the marketplace. Taking into account the policy which best serves the prime purpose of the Act, viz. insuring "fair practice and honest dealing on the commodity exchanges and . . . [providing] a measure of control over those forms of speculative activity which too often demoralize the markets to the injury of producers and consumers and the exchanges themselves," the doctrine of in pari delicto must give way, at least insofar as defendants are charged with intentional failure to maintain the market. A different rule may be appropriate where plaintiff has acted wantonly and wilfully, and where defendant merely has been negligent, Cf. Tartell v. Chelsea Nat'l Bank, 351 F. Supp. 1071, 1079 (S.D.N.Y.) aff'd, 470 F.2d 994 (2d Cir. 1972), because in such circumstances the policing effect of permitting private actions to proceed may be substantially diminished. However, we need not reach this question until appropriate factual determinations are made at trial.

 Liability of the Clearing Association

 The Clearing Association urges, as a threshold matter of law, that it cannot be liable under the first cause of action because it has neither a statutory nor a self-imposed duty to maintain an orderly market. It is neither a "contract market" (exchange), member of a "contract market", "commission merchant", nor "broker ", and therefore is not required to register under the Act. 7 U.S.C. §§ 2 and 12a. Neither it nor its directors exercise any control over trading; rather, its function is simply to "clear" contracts.

 Plaintiff, however, points to the prominent role in fact played by the Association in restricting the activity of its customers and in regulating the market, and submits as an example a letter dated April 25, 1963, from Perry E. Moore, a member of the Association's board of directors, to Weinstein, President of the Association. Moore's letter refers to a discussion during an April 22, 1963, Association board meeting concerning future margining of a firm denominated "N", which firm was engaged in large offsetting "ex-pit" transactions (trades consummated other than by open outcry on the "floor" of the Exchange). Moore suggested applying a system of "scale-up" margins to "N".

 On August 13, 1963, at an Association board meeting Weinstein expressed "mounting concern over the increasing concentration [of futures contracts] in the hands of a few firms." This concentration was being effected by "apparently affiliated interests" by means of "expit" transactions. The Board authorized Weinstein to advise the Exchange of the Association's concern, to suggest that the Exchange adopt a scale-up system of margining, and to advise the Exchange that should the concentration persist, the Association would be forced to consider increasing its own margin requirements. Weinstein so advised MacDonald in two letters, both dated August 16, 1963.

 The record of a September 23, 1963, Exchange-Association meeting, in a section entitled "Relationship of Exchange and Association" states, in pertinent part:

 
"(B) Association has jurisdiction only over its Clearing Members on matters of positions carried and original margin requirements and no jurisdiction over trading procedures, etc.
 
"(c) To provide effective control, and to safeguard interests of both the Exchange and the Association, close cooperation between them is needed in such matters."

 After describing the scale-up system of margining under consideration by the Association, the record states:

 
"Exchange should consider a similar system of margin requirements in order to reach the customers of Clearing Members who cannot be reached by the Association."

 On October 8, 1963, Weinstein reported meeting with the Manager of the Association (defendant Boyer) and with the President, Treasurer, and Managing Director of the Exchange, (defendants MacDonald, Fashena, and Berg), and discussing margin requirements. The officers agreed that the Association ought to act first "in view of the dangerous situation" created by cottonseed oil concentration. Following the report, a scale-up system was adopted, effective November 15, 1963. On October 10, 1963, Weinstein met with Jack Stevens, the Operations Manager of Haupt, at Stevens' initiative. Weinstein informed Stevens that the margin increase would not be rolled back, questioned him about Haupt's handling of the Allied account, and impressed upon him the seriousness of "the situation."

 One last objective fact tending to establish a partnership in regulation between the Association and the Exchange is the fact that the Association's board of directors met with the Exchange Executive Committee on November 19, 1963, at which meeting it was effectively decided that trading should be suspended the following morning.

 Board of Trade v. Wallace, 67 F.2d 402 (7th Cir.), cert. denied, 291 U.S. 680, 54 S. Ct. 529, 78 L. Ed. 1067 (1933) suggests that a clearing association performing functions essential to trading on a contract market (i.e. exchange) may be subject to the purview and responsibilities of the Act. Wallace involved an appeal from an order (of a Commission constituted under the Grain Futures Act, the predecessor statute of the Commodity Exchange Act) suspending the Board of Trade's designation as a contract market for 60 days because of the Board of Trade Clearing Corporation's refusal to admit the Farmers National Grain Corporation to membership. Pointing out that it and the Clearing Corporation were distinct entities incorporated in different states, the Board of Trade argued that it was not responsible for the Clearing Corporation's denial of membership. The Court disagreed, observing that "[the] right to clear trades made on the board cannot be separated from the right to make trades on the board without seriously impairing market facilities." Id., at 406.

 The court focussed on the relationship between the two corporations.

 
"The chronology of events strongly suggests that the board, with design to place this essential facility or privilege of a contract market beyond the control of the Secretary of Agriculture, abandoned the practice of itself clearing the trades by creating a separate corporation to take over this function.
 
"But in view of all the facts it is plain that . . . in reality the clearing of trades remained as completely as ever before within the absolute power and control of the board." Id., at 406.

 For example, a board rule stated that board member's trades had to be cleared through the clearing corporation. "Membership in the clearing corporation, the personnel of its board of governors, its by-laws, rules, and regulations, remained and are at all times under the control of the Board of Trade." Id. In fact, the clearing corporation could not amend its by-laws without the consent of the Board of Trade. Finally, the Board, through ...


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