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Wong v. New York Mercantile Exchange

decided: May 11, 1984.

SAM WONG & SON, INC., A CORPORATION, ON BEHALF OF ITSELF AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFFS-APPELLANTS,
v.
NEW YORK MERCANTILE EXCHANGE, RICHARD B. LEVINE, HOWARD GABLER, MELVYN FALIS, JAYNE BALL, ALFRED S. PENNISI, PETER JOHNSTON, MICHEL MARKS, VICTOR BUCCELLATO, SALVATORE CALCATERRA, HORACE DE PODWIN, SAM FISHBERG, RICHARD JARECKI, STANLEY MEIERFELD, CHARLES MILLER, HENRY POLAN, JACK SCHWAGER, IRA SHEIN, JACOB STERN, DENNIS SUSKIND, SOL TANNE, HARVEY WACHMAN, NORTON WALTUCK, JOE DOE, JANE ROE, RICHARD COE, MARY SMITH, ABC, INC., DEF, INC., GHI, INC., JKL, INC., MNO, INC., AND PQR, INC. (THE LAST TEN NAMES BEING FICTITIOUS), DEFENDANTS-APPELLEES; ANTHONY SPINALE, PLAINTIFF-APPELLANT, V. NEW YORK MERCANTILE EXCHANGE, MICHEL MARKS, DENNIS SUSKIND, SAL CALCATERRA, NORTON WALTUCK, GEORGE GERO, STANLEY MEIERFELD, HORACE DE PODWIN, JACK SCHWAGER, SAM FISHBERG, IRA SHEIN, JACK PLACE, HARVEY WACHMAN, AND CHARLES MILLER, DEFENDANTS-APPELLEES



Appeals by two commodities traders, Sam Wong & Son, Inc. and Anthony Spinale, who had brought actions against the New York Mercantile Exchange and its governors and officers for conduct relating to the March, April and May 1979 Maine round white potato futures contracts, from orders of the District Court for the Southern District of New York, Abraham D. Sofaer, Judge, reported sub nom. Jordon v. New York Mercantile Exchange, 571 F. Supp. 1530 (S.D.N.Y. 1983). One order dismissed or, in the alternative, granted summary judgment to the defendants with respect to Wong's action; another granted summary judgment to the defendants with respect to Spinale's. Affirmed with respect to Wong's action; reversed and remanded to permit limited discovery with respect to Spinale's.

Friendly, Timbers and Meskill, Circuit Judges.

Author: Friendly

FRIENDLY, Circuit Judge:

We have here appeals by plaintiffs, Sam Wong & Son, Inc. (Wong) and Anthony Spinale, in two suits in the District Court for the Southern District of New York against the New York Mercantile Exchange (NYME or Exchange), its Board of Governors (the Board), and various NYME officers. Both suits concern action or inaction by the NYME relating to the March, April and May 1979 Maine round white potato futures contracts. After an all night meeting on March 8-9, 1979, the Board declared that, in consequence of large-scale failures of the March potatoes to meet delivery standards at the Hunts Point Terminal Market in the Bronx, New York, a market emergency existed with respect to the three contracts, suspended trading in the April and May contracts,*fn1 and ordered those contracts to be liquidated at the March 8 settlement price. The Board also ordered a two-day extension in the delivery period for the March contracts and provided that unfulfilled March contracts would be settled at a price to be determined by a special committee.

Wong's complaint, filed on behalf of himself and "all other producers, owners, processors or merchandizers [sic] of 1978 crop year potatoes grown in the United States who assumed short positions" in the 1979 Maine Potato contracts to hedge against a decline in the value of their crops,*fn2 made two principal claims. One was that, once the delivery problem had manifested itself in November, 1978, the NYME had failed to take proper action earlier than March 8-9. The other was that the NYME had failed in a duty to revise the Maine round white potato futures contract so that it would be a better vehicle for hedging and less susceptible to the problem that had developed in 1976*fn3 and again in the controversy here before us. Spinale held net long positions in the March, April and May contracts;*fn4 he attacked the action taken at the March 8-9 meeting, which had deprived him of further profits he would have obtained if the NYME had not acted or had acted less drastically. His complaint, almost the exact opposite of Wong's, was that the Exchange should not have taken emergency action when it did, and alternatively that any action should have been less drastic and should not have included the March contract, see supra note 1. Judge Sofaer, in a comprehensive and scholarly opinion, reported sub nom. Jordon v. New York Mercantile Exchange, 571 F. Supp. 1530 (S.D.N.Y. 1983), familiarity with which is assumed, directed that Wong's complaint should be dismissed for failure to state a claim on which relief can be granted, Fed. R. Civ. P. 12(b)(6), or, alternatively, that summary judgment should be granted to defendants under Fed. R. Civ. P. 56. He also granted summary judgment dismissing Spinale's complaint. These appeals followed.

The Facts*fn5

The NYME Maine Round White Potato Futures Contract calls for the delivery of 500 cwt. (hundredweight) of Maine grown potatoes of any but the Cobbler and Warba varieties, which are excluded because of their irregular shapes. The contract requires the potatoes to be packaged in 1000 fifty-pound bags. Delivery months are November, March, April and May. The Maine potato crop is harvested in the fall; thus the November contract marks the beginning of the crop year. Delivery may be made by rail or truck. In fact all deliveries have been made by truck since this was first permitted in the May 1977 contract. Each delivery generally consists of one truckload of potatoes, i.e., the contract amount of 50,000 pounds. The potatoes must grade U.S. No. 1 for par delivery, except that for the April and May contracts "commercials" are deliverable at a 25% discount from the settlement price for the last trading day of the delivery month. The contract requires two inspections -- one by a federally-authorized state inspector at the point of origin in Maine and the other by a federal inspector at the final point of destination at the Hunts Point Terminal Market, the Bronx, New York, or Everett, Massachusetts. The grading standard follows the United States Standards for Grade of Potatoes promulgated by the Secretary of Agriculture.

The first deliveries of Maine round white potatoes for the 1978-1979 crop year began for the NYME on November 6, 1978 and continued until November 20. An open interest of ninety-two contracts remained after the termination of trading in the November 1978 contract. Ultimately deliveries were tendered to close fifty contracts; the remaining contracts were liquidated pursuant to the Exchange's "EFP" procedure, see infra. Of the fifty deliveries, all of which had passed inspection in Maine, fifteen failed to pass inspection at Hunts Point.*fn6 Eleven loads failed because of apparent deterioration since inspection in Maine; the potatoes arrived at Hunts Point with high percentages of sunken and discolored areas that exceeded the Department of Agriculture's (USDA) specifications for the U.S. No. 1 grade. The other four failures were "reversals" based on grading characteristics that should have been detected at the point of origin.

The November rejections prompted the NYME to take a look. On November 21 the Exchange's Potato Control Subcommittee (Control Committee) reviewed the results of the delivery period and tentatively concluded that "no problems were foreseeable". Nevertheless, the Control Committee recommended sending a letter to the USDA relating to the inspection reversals and failures. On December 14, Richard Levine, president of the NYME, wrote such a letter to a USDA official, Ligon Johnson, head of the Grading Section, Fresh Products Branch of the Fresh Fruit and Vegetable Quality Division, in Washington, D.C., specifically asking an opinion on how the delivery problem arose and whether similar difficulties would occur in the future. After conducting a preliminary investigation, Johnson responded on January 18, 1979. He commented that apparently "this year's crop of Maine potatoes, even after being sorted, have [sic] a higher than usual percentage of borderline defective specimens." Regarding the inspection reversals, he assured Levine that steps had been taken to bring about uniformity in inspectors' grading standards. Lastly, he tried to assuage any of the Exchange's concerns by stating that the USDA was "prepared to take additional action if necessary to prevent a recurrence of the embarrassment encountered this past November."

During January and February, 1979 the NYME continued to monitor the situation with respect to the Maine potato crop and the 1979 futures contracts. Notwithstanding its initial concern over the November deliveries, the NYME concluded that this was not a serious portent. The Control Committee reconvened on January 29 to discuss the USDA's response; the group was concerned primarily with the discrepancies between the Maine and New York inspections, a problem which the USDA appeared to have under control. Neither the Control Committee nor the Board at its regular February meeting focused much attention on the quality of the year's potato crop. Exchange officials knew from experience, however, that farmers may have a tendency to be more lax in their own grading standards with respect to potatoes sold and delivered early in the season. Moreover, both the NYME's field representative in Maine and its monitoring staff based in New York reported during this period that there was a sufficient deliverable supply of potatoes.*fn7 As described by the CFTC report, during January and February, 1979, "with the November experience behind it, neither the Control Subcommittee nor the Board requested the Exchange staff to do anything other than their usual monitoring. Nor was anything other than the usual monitoring undertaken."

What followed is best presented by the description in the CFTC report:

During the week of March 5-8, 1979, the Exchange was faced with the failure of 29 out of 32 loads presented for the point of destination inspection in Hunts Point for condition defects, primarily sunken and discolored areas. . . . The April and May, 1979 contracts had closed on Friday, March 2, at $6.30 and $7.03, respectively. The close of trading on Thursday, March 8, found April at $7.60 and May at $8.14. In contrast, the cash price at Hunts Point for this period remained steady at $5.85. During these four days, the open interests in the May contract declined by nearly 3,000 to 10,000 contracts. Trading in both contracts locked up the limit of 50 cents on Monday and touched the limit on Wednesday. Otherwise, the market traded freely. (Emphasis supplied).*fn8

As the delivery failures unfolded during the week, the NYME made efforts to obtain information. Apart from utilizing its own staff, the Exchange contacted officials at the USDA, spoke with traders who were short hedgers, clearing members and representatives of the Maine potato industry, and consulted with the CFTC.

The NYME's discussions with the USDA focused on whether the Maine and New York inspectors were applying different standards. Although a definitive answer was not possible under such time pressures, the USDA found nothing to indicate inspection inconsistencies. Faced with the fact that potatoes making the grade in Maine failed inspection in New York, an unusual circumstance because the truck route lasted only twelve to eighteen hours, the USDA thought an explanation might be found in the crop's quality.

On Tuesday, March 6, the Administrative Committee of the NYME held an unusual meeting with a short hedger. The Committee customarily chose not to hear individual matters. The trader, who was well respected in the market, stated that he was making every effort to obtain good deliverable potatoes but was having difficulty in doing so. Subsequently, another trader notified the Exchange of his delivery problems. In addition, the NYME's field representative reported concerns expressed by members of the Maine potato industry over the recent delivery rejections.

The NYME was also in contact with the CFTC about the problem and what, if anything, should be done about it. Various courses of action were discussed back and forth, including the issuance of public statements by both organizations and the possibility of joint emergency action.*fn9

By the evening of Thursday, March 8, the Exchange staff had become convinced that the real problem was with the quality of the crop and that any inspection inconsistencies should be discounted.*fn10 If this was so, the situation could fairly be expected to worsen as the season advanced. The NYME staff was considering various emergency actions such as modifying the terms of delivery, temporary suspension of trading, increasing margins 100% and directing that trading be limited to liquidation of existing contracts. Although the Exchange's Maine field liaison had suggested to Levine to have the NYME stand pat, this idea was not seriously discussed.

In a telephone conversation late in the afternoon of March 8, Michel Marks, the chairman of the NYME, told Gary Seevers, the acting chairman of the CFTC, that he had considered calling the Board into session the following day to discuss the potato situation but deemed it to be so serious that he had decided instead to convoke the Board that evening. Apart from the immediate March delivery problem, the Exchange was concerned with maintaining viable futures contracts for April and May, i.e., those that reflect the real economic value of the potato crop. The meeting began at 9:15 p.m. on Thursday and lasted until 4:30 a.m. on Friday. Eleven of the fifteen governors were present as were the Exchange's president Levine, outside counsel and the Board's chairman emeritus. Four of the governors, Chairman Marks, Sam Fishberg, Salvatore Calcaterra and Stanley Meierfeld, were considered to be especially knowledgeable about the potato market.

President Levine began the meeting with a report reproduced in the margin.*fn11 After examination of reports of inspection on the March deliveries and information with respect to past inspection failures presented by the Clearing House Manager, the Board considered the question of possible conflicts of interest, with results indicated in the margin.*fn12 The abbreviated minutes of the meeting recite that after extensive discussion which "focused on the unusually high rate of failure of inspections in New York and the inability of potatoes to meet the contracts' standards" and advice from counsel, the Board adopted a series of resolutions.*fn13 One, which was passed unanimously, declared that "an emergency exists which threatens or may threaten the fair and orderly trading in and the liquidation of and delivery under the April 1979 and May 1979 Round White Potato Futures Contract[s] which emergency requires immediate action." A second, adopted by eight of the members present, with three abstaining, resolved that trading in the April and May 1979 contracts shall be suspended and that all open contracts be liquidated at a settlement price of $7.60 per cwt. for the April contract and $8.14 per cwt. for the May contract, these being the settlement prices at the close of trading on March 8, 1979. A third resolution, adopted by a vote of nine of the eleven members present, with two abstaining, declared the existence of an emergency requiring immediate action with respect to the March 1979 contract. Two further resolutions were adopted concerning the March contract by a vote of eight of the ten members present;*fn14 one member abstained and another voted in the negative. One resolution extended for two days, until March 23, the delivery period for the March contract; the other provided that with regard to all March contracts not fulfilled by delivery on March 23, the sellers shall be deemed not to have failed to perform and the contracts shall be liquidated at a settlement price to be determined by the Exchange. A special committee of three outside experts later fixed this at $6.34 per cwt., the settlement price of the March contract at the close of trading on February 28, 1979; the NYME adopted the committee's recommendation on May 23, 1979.

Pursuant to CFTC regulation 1.41(f)(2), 17 C.F.R. § 1.41(f)(2), discussed infra, the NYME, on Friday morning, March 9, promptly notified the Commission of the emergency resolutions adopted during the night. On March 19, the Exchange furnished the Commission with a written explanation of the emergency and the action taken to meet the problem; the Exchange thereafter supplemented this information by various correspondence over the next several months.*fn15

The Relevant Statutes, Regulations of the CFTC and By-Laws and Rules of the NYME

The Commodity Exchange Act (CEA), 7 U.S.C. §§ 1 et seq., has been accurately described as a "comprehensive regulatory structure to oversee the volatile and esoteric futures trading complex." H.R. Rep. No. 975, 93d Cong., 2d Sess. 1 (1974).*fn16 Section 5 of the CEA, 7 U.S.C. § 7, authorizes and directs the CFTC to designate a board of trade as a "'contract market'" "when, and only when, such board of trade complies with and carries out" the conditions and requirements listed in seven subparagraphs. One of these, § 5(a), is that, unless otherwise approved by the CFTC, the board of trade shall be "located at a terminal market where any cash commodity of the kind specified in the contracts of sale of commodity for future delivery to be executed on such board is sold in sufficient volumes and under such conditions as fairly to reflect the general value of the commodity and the differences in value between the various grades of such commodity, and where there is available to such board of trade, official inspection service approved by the Secretary of Agriculture or the Commission for the purpose."*fn17 Another condition and requirement of contract market designation, § 5(d), is that the board of trade "provides for the prevention of manipulation of prices and the cornering of any commodity by the dealers or operators upon such boards." A third relevant provision, § 5(g), is that the board of trade "demonstrates that transactions for future delivery in the commodity for which designation as a contract market is sought will not be contrary to the public interest."*fn18

Section 5a, 7 U.S.C. § 7a, imposes duties on contract markets. We quote § 5a(4), (8) and (10) in the margin.*fn19 Section 5a(12) requires the contract market to submit to the CFTC for its approval all by-laws, rules, regulations and resolutions which relate to terms and conditions in contracts of sale or other trading requirements except those relating to the setting of levels of margin. Also, of direct relevance here, it provides:

The Commission shall specify the terms and conditions under which a contract market may, in an emergency, as defined by the Commission, adopt a temporary rule dealing with trading requirements without prior Commission approval. In the event of such an emergency, as defined by the Commission, requiring immediate action, the contract market by a two-thirds vote of its governing board may place into immediate effect without prior Commission approval a temporary rule dealing with such emergency if it notifies the Commission of such action with a complete explanation of the emergency involved.*fn20

Pursuant to the authority conferred by § 8a(5), 7 U.S.C. § 12a(5), the CFTC has adopted Regulation 1.41, 17 C.F.R. § 1.41. Section 1.41(a)(4) broadly defines the term "emergency", as follows:

The term "emergency" means:

(i) Any occurrence or circumstance specifically defined as an "emergency" by the rules of a contract market which have been submitted to the Commission pursuant to section 5a(12) of the Act; and

(ii) Any other occurrence or circumstance which, in the opinion of the governing board of the contract market, requires immediate action and threatens or may threaten such things as the fair and orderly trading in, or the liquidation of or delivery pursuant to any contract for the future delivery of a commodity or any commodity option on such contract market. Occurrences and circumstances which a governing board of a contract market may deem emergencies include, but are not limited to:

(A) Any manipulative activity or attempted manipulative activity;

(B) Any actual, attempted, or threatened corner, squeeze, congestion, or undue concentration of positions;

(C) Any circumstances which may materially affect the performance of contracts or commodity options traded on the contract market;

(H) Any other unusual, unforeseeable and adverse circumstance with respect to which it is impracticable for the contract market to submit, in a timely fashion, a rule to the Commission for review under section 5a(12) of the Act.

Section 1.41(a)(6) provides, inter alia, that the requirement of a "two-thirds vote of a governing board" is satisfied by the affirmative vote of two or more persons constituting not less than two-thirds of the members of the governing board physically present and voting at a meeting at which a quorum of at least one-third of the members is physically in attendance. Section 1.41(f)(2) requires the contract market to notify the CFTC of the adoption of a temporary emergency rule by the fastest available means of communication and promptly thereafter to send the CFTC a written copy of the rule. Section 1.41(f)(3) provides, in pertinent part, that a temporary emergency rule may provide for actions necessary or appropriate to meet the emergency "including, but not limited to, such actions" as:

(i) Limiting trading to liquidation only, in whole or in part, or limiting trading to liquidation only except for new sales by parties who have the ...


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