The opinion of the court was delivered by: HAIGHT
MEMORANDUM OPINION AND ORDER
The complaints in these two actions allege separate schemes to defraud plainitiff Merrill Lynch Futures Inc. ("MLF"). On April 4, 1984, the Court, pursuant to Rule 64, Fed.R.Civ.P., signed an ex parte order in civil action 84 Civ. 2406 attaching assets of defendants Kelly, Miller, and Villeroel and temporarily enjoining their expenditure of certain funds. Two days later a similar order was entered by Hon. Milton Pollack, sitting in Part I, in civil action 84 Civ. 2485 against defendants Morici and Villeroel. The actions were consolidated solely for the purpose of holding hearings on confirmation of the orders of attachment and entry of a preliminary injunction. Following an initial round of arguments, in a Memorandum Opinion and Order of April 17, 1984, I dissolved the temporary restraints, denied the preliminary injunctions, and declared the attachment of Morici's assets to have been improvident because the supporting affidavits were insufficient. Morici's assets remain attached, however, because plaintiff submitted a second, more detailed application for an order of attachment the next day.
Pursuant to plaintiff's motion to confirm the orders of attachment, required by N.Y.C.P.L.R. § 6211, three days of evidentiary hearings were held at which an MLF investigator testified. In order to expedite decision, the remainder of a substantial amount of testimony was submitted by stipulation. Soon after the last day of evidentiary hearings, defendant Villeroel consented to confirmation of the orders of attachment against her assets. It remains to be decided whether the orders entered against defendants Kelly, Miller, and Morici should be confirmed.
To succeed on a motion to confirm an order of attachment, a plaintiff must establish 1) a ground for the attachment, 2) the existence of a cause of action, 3) the probability that it will succeed on the merits, 4) the need for continuing the levy, and 5) the probability that the amount demanded from the defendants exceedsd their potential counterclaims. N.Y.C.P.L.R. §§ 6212 (a), 6223; Executive House Realty v. Hagen, 108 Misc.2d 986, 438 N.Y.S.2d 174, 177 (Sup.Ct. 1981); Irving Trust Co. v. Gomez, 550 F. Supp. 773, 774 (S.D.N.Y. 1982). The two actions will be discussed separately.
With regard to 84 Civ. 2406, two of the five elements can be quickly considered. In the Memorandum Opinion and Order of April 17, 1984, I considered the issue of a proper ground for attachment and decided that the defendants' residence outside New York provided such a ground under N.Y.C.P.L.R. § 6201(1). Third, the need to ensure that a judgment in its favor will be satisfied provides plaintiff with an adequate reason for requesting continuation of the levy against these out-of-state defendants. See Irving Trust Co. v. Gomez, supra, 550 F. Supp. at 774. Although there are currently no counterclaims, defendants have raised questions about the adequacy of the showing of damages. These are discussed below.
The primary issue is whether plaintiff has demonstrated a probability of success on the merits. The bulk of the testimony was presented by Joseph F. Texido, Compliance Director at MLF, who testified to the results of a recent investigation into irregularities in the "error accounts" at MLF. Defendant Villeroel was until recently the manager of the error unit at MLF and as such was apparently in charge of administration of these accounts. Explaining their significance will require a review of basic procedures in commodities trading.
Brokerage houses such as MLF ordinarily trade commodities futures only at the request of their customers. When a customer wishes to initiate a trade, he contacts a MLF account executive at one of its branch offices. The account executive records the order on an "order ticket" and transmits the text of the ticket by wire or phone to the floor of the Commodities Exchange ("Comex"). An identical order ticket is then written up on the Comex floor and carried by runner to the floor brokers in the trading "rings." MLF has several floor brokers in its employ, but from time to time it also employs various independent brokers. The job of the floor broker is to execute the trade at "open outcry" -- that is, to locate in the ring another floor broker who wishes to accomplish a corresponding trade. If the MLF broker wishes to trade contracts to purchase futures in a particular commodity, he must find another broker wishing to trade contracts to sell the same futures at a mutually agreeable price. Following consummation, the floor brokers record the trade on their trading cards, documents which indicate the trades executed by individual floor brokers during the trading day, and mark the order tickets. The marked ticket is returned to a clerk on the floor who reports filling of the order to the appropriate MLF branch office. Later the trades recorded on the trading cards are transcribed by a "write-up clerk" and reported to the Comex clearing house, which prepares daily reports of trading activity.
From the foregoing it is clear that the process of filling a customer's order is fraught with potential for mistake. The purpose of the error unit is to minimize the damage caused by these inevitable mistakes. Once MLF becomes aware that an erroneous trade
has occurred, the error is reported to the error desk. The duty of the error unit is to "liquidate" the error as soon as possible by executing an offsetting trade
so as to minimize any losses occasioned by the error. These trades are entered in the appropriate error account and "allocated" to the party responsible for the error. Separate error accounts are maintained for errors committed by wire and order personnel, branch office personnel, and floor brokers. If the error results in a loss, half of the loss is deducted from the compensation of the individual responsible for the error. Profits from erroneous trades are kept by MLF. Once an erroneous trade has been liquidated and allocated, it is transferred out of the error accounts. Ideally the process is completed within a day of the error unit's learning of the error.
In December 1983 an investigation by Mr. Texido's office revealed several longstanding unallocated, unliquidated trades in the error account. (Transcript, at 36). The existence of such trandes caused concern at MLF. for it not only suggested improper management of the error accounts but exposed MLF to significant financial risk. The risk occurred because the trades, not being liquidated, remained "open." If the market declined, MLF, which owned the trades once they were placed in the error accounts, lost money. (Tr., at 38). By early December the realized and unrealized losses associated with open (unliquidated) positions in the MLF error accounts amounted to approximately $615,000. (Tr., at 38-39).
This brief description of the trading process demonstrates that every trade executed by MLF on customer order leaves a paper trail consisting of the order ticket written up at the branch office and reprinted on the floor of the exchange and the trading card filled out by the floor broker. Investigation by MLF failed to disclose any of these documents corresponding to the open, unallocated trades in the error account. (Tr., at 91). Nor were there any of the memoranda which MLF requires responsible parties to file describing the cause of their errors. (Tr., at 44, 46). Because the trades were unallocated, there was no indication of who caused them. In addition, an interesting pattern emerged: in all or most of these unallocated trades, the "opposite clearing member" -- that is, the Comex member which executed the opposite side of these trades -- was Prudential-Bache Securities. (Tr., at 46). Further investigation revealed that a particular Prudential-Bache account executive, defendant Miller, executed trades which were equivalent to the opposite side of most of these suspect MLF trades on the days on which the trades occurred. For example, the first such suspect trade, executed on August 25, 1983 and reported on August 26, 1983, was for thirteen contracts to buy December '83 silver at $13.03 per ounce. The opposite clearing member was Prudential-Bache, and Miller's trading records show a trade as of August 25, 1983, to sell thirteen contracts of December '83 silver at $13.03. (Tr., at 62). Similar unallocated trades occurred as of October 6, October 19, October 27, November 28, and November 29. (Tr., at 73, 80-82, 86, 89, 94). Corresponding opposite trades were found in Miller's trading records for all trades except the one occurring as of October 27. (Tr., at 74, 86, 90, 337, 338, 340-343, 344-346). After discovering these open trades MLF closed them out, but intervening changes in the silver market resulted in losses to MLF of $353,000. (Tr., at 105, 219, 241, 241).
MLF's theory is that Miller, Kelly, and Villeroel worked together to execute these trades off the floor of the Comex and then to hide them in the error accounts at MLF. In this way, MLF was caused to accept trades it neither ordered nor wanted. According to the complaint, Miller initiated the trades, Kelly forged documents which caused the trade to appear to have been executed on the Comex floor by a floor broker employed by Kelly's employer, and Villeroel accepted the trades on behalf of MLF by placing them in the error accounts. The purpose of the alleged scheme was apparently to permit the three to make trades which had the legal effect of normally-executed trades but which did not require participation in the trading rings. This presumably permited the three to profit by making trades at prices more favorable than the prices prevailing in the rings at the time the trade was made. Those prices would, of course, have been equally unfavorable to MLF, but this fact was hidden by placing the trades in the error accounts and then shuffling them among the three accounts to avoid detection.
Although none of the defendants has contended that the complaint fails to state a cause of action under the commodities Exchange Act ("The Act"), the issue is ...