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United States District Court, Southern District of New York

February 2, 1999


The opinion of the court was delivered by: Kaplan, District Judge.


This case involves an allegedly fraudulent commodity operation, Hanover Trading Corporation ("Hanover") and presents a significant issue regarding the propriety of ordering disgorgement by a so-called "relief defendant" — one who is not charged with wrongdoing — of money allegedly traceable to the alleged wrongdoers.


The complaint in this case contains three causes of action. The first alleges that defendants Hanover, Dupont, Singer and Droge (the "Principal Defendants") violated Section 4b(a) of the Commodity Exchange Act (the "Act")*fn1 by making material false statements and omissions in connection with orders to make, or the making of, contracts of sale of commodities for future delivery ("futures contracts"), misappropriating customer funds, and issuing false reports to customers. The second alleges violations by the Principal Defendants of Section 4(a) of the Act*fn2 in that the alleged futures contracts were sold in unlawful off-exchange transactions. The third seeks disgorgement by Aronowitz and the other relief defendants on the theory that the funds that are the subject of the claim are directly traceable to the proceeds of the fraud carried out by the Principal Defendants, that the relief defendants are not bona fide purchasers with legal and equitable title to the funds they received, and that the relief defendants would be enriched unjustly absent disgorgement. The case has been disposed of as to all Principal Defendants and relief defendants but Aronowitz. Singer has pleaded guilty to criminal charges in connection with these events.*fn3

Plaintiff Commodity Futures Trading Commission (the "CFTC") moves for summary judgment requiring relief defendant Paul Aronowitz to disgorge the sum of $73,599.01 plus interest. In an order dated December 28, 1998, this Court struck Aronowitz's untimely papers in opposition to the Commission's summary judgment motion. In accordance with Local Civil Rule 56.1, all of the factual assertions contained in Plaintiff's Statement of Facts Not in Dispute ("Pl. 56.1 St.") therefore are deemed established for purposes of the motion. The remaining question is whether, given those facts, the CFTC is entitled as a matter of law to the judgment it seeks.*fn4 The only points warranting discussion in that regard are whether (1) the investments sold by defendant Hanover Trading Corp. ("Hanover") were futures contracts within the meaning of the Act and thus within the CFTC's jurisdiction and, if so, (2) disgorgement is an appropriate remedy against Aronowitz on the facts of this case.

Briefly stated, the facts are these. Hanover was engaged in selling an investment program involving commodities through telephone solicitation or telemarketing. None of the contracts it sold to its customers was concluded on a registered contract market, and so all violated Section 4b(a) of the Act if they were futures contracts. Moreover, Hanover's solicitations were fraudulent, and it misappropriated customer funds.

Aronowitz worked for Hanover. He solicited investments in these futures contracts through telemarketing, helped defendant Singer run the Hanover office, interviewed potential telemarketers and trained those whom Hanover hired, participated in fraudulent solicitations himself, and spoke with customers who had complaints.*fn5 He knew that Hanover itself did not purchase physical commodities and told customers that they would not have to take delivery.*fn6 He also used an alias on a letter sent to new customers in an apparent attempt to create the impression that Hanover was more substantial an operation that in fact it was.*fn7 Nevertheless, the complaint does not accuse Aronowitz of any violation of law and, as will appear, the Commission has not charged him in this motion with knowledge of the fraudulent nature of Hanover's conduct.

The Commission seeks to have Aronowitz disgorge the proceeds of 48 checks drawn on Hanover bank accounts and paid to Aronowitz as commissions with respect to investments he solicited for Hanover.*fn8 Hanover's source of those funds was payments of customers in respect of the illegally solicited investments.*fn9


As the facts set forth in the Commission's Rule 56.1 statement are established for purposes of the motion, there are but two issues requiring discussion — whether the investments marketed by Hanover were futures contracts subject to the jurisdiction of the CFTC and whether the Commission is entitled to disgorgement from Aronowitz on these facts.

Futures Contracts

While the statute does not define contracts for future delivery, or futures contracts, the cases demonstrate that they have two salient characteristics. First, futures contracts are contracts for the purchase or sale of a commodity for delivery in the future at a price that is established at the time the contract is initiated.*fn10 Second, the ability to offset the obligation to purchase by selling the contract, or to offset the obligation to deliver by buying a contract, "is essential, since investors rarely take delivery against the contracts."*fn11 The lack of an expectation that delivery of the physical commodity will be made is an important factor indicating the presence of a futures contract.*fn12

Hanover's contracts involved the purchase of commodities for future delivery at prices agreed when the transactions were initiated. The "positions" were purchased in the expectation that they would be offset by selling transactions. There was no intention or expectation that Hanover's customers ever would take delivery.*fn13 In consequence, the investments sold by Hanover were futures contracts.*fn14 The claims asserted here therefore fall under the Act and within the jurisdiction of the CFTC.


The Commission seeks disgorgement of the payments to Aronowitz on two theories. First, it argues that the money paid to Aronowitz was obtained illegally by Hanover and that Aronowitz has no legitimate ownership interest in it.*fn15 In any case, it maintains, a constructive trust should be imposed upon those funds because they were obtained illegally by Hanover and such relief is warranted to avoid unjust enrichment of Aronowitz.*fn16

The first of the Commission's arguments depends upon the proposition that Hanover never held any legitimate interest in the funds because its agreements with investors violated the Act and, unlike contracts in violations of the federal securities laws, were void rather than merely voidable.*fn17 The argument seems to be that Hanover could not pass any interest to Aronowitz because Hanover itself never had any interest in the money.

The Commission points to nothing in the Act that provides that a contract in violation of its terms is void. The only authority it cites for this proposition is an administrative consent order, Matter of MG Refining and Marketing, Inc.,*fn18 an authority of limited value to begin with.*fn19 MG Refining, moreover, merely recited that certain agreements were off-exchange contracts which were "illegal, and therefore void, under Section 4(a) of the Act . . ."*fn20 But Section 4(a), while rendering off-exchange futures contracts unlawful, does not state that they are void as opposed to voidable. Moreover, the Commission's argument here flies in the face of a plethora of authority holding that even contracts made in violation of the securities laws, and thus subject to Section 29(b) of the Securities Exchange Act of 1934,*fn21 which states that such contracts are "void," are merely voidable at the option of the innocent party.*fn22

The fact that transactions in violation of the Commodity Exchange Act are no more than voidable requires rejection of the Commission's first argument. In SEC v. Levine,*fn23 the Second Circuit held that defendants had acquired property interests in the proceeds of allegedly unlawful securities transactions notwithstanding the voidability of those transactions.*fn24 While the Court recognized that "a party who acquires property from a defrauding party and who has actual knowledge of the fraud may himself acquire only voidable title,"*fn25 the Commission has neither alleged nor proved actual knowledge by Aronowitz of the fraudulent nature of Hanover's conduct. The Commission's Rule 56.1 Statement, while establishing facts from which one might draw an inference of such knowledge, carefully avoided asserting that he had actual knowledge of the fraudulent character of Hanover's activities.*fn26 As the CFTC's papers in support of its motion for summary judgment must be viewed in the light most favorable to the non-moving party,*fn27 the Court may not draw that inference on this motion.

The second of the Commission's arguments presents its own problems. It often is said that "disgorgement does not penalize, but merely deprives wrongdoers of ill-gotten gains."*fn28 In ordinary circumstances, therefore, there is no basis for disgorgement by an innocent party. Indeed, Levine reversed a district court order imposing a constructive trust on the proceeds of the allegedly unlawful securities transactions precisely because the district court did so on the basis of previous consent decrees and therefore without any adjudication of wrongdoing.*fn29

To be sure, it is well established under the securities and, by analogy, the commodities laws that district courts, at the behest of the SEC and CFTC, respectively, in appropriate cases may reach funds held by non-parties. But that power is not entirely boundless.

In Deckert v. Independence Shares Corp.,*fn30 the wellspring of this authority, the Supreme Court in relevant part merely held sufficient a bill in equity seeking restitution from a relief defendant of funds held by the relief defendant "for account of [the principal defendant], which consisted in part of the payments alleged to have been procured by the fraud of" the principal defendant.*fn31 Thus, the bill did not seek recovery of funds to which the relief defendant had a claim of entitlement in his own right. Subsequent cases have extended Deckert to permit recovery from relief defendants, irrespective of their culpability, who possess illegally obtained profits and have no legitimate claim to them.*fn32 perhaps the broadest extension came recently in SEC v. Antar,*fn33 where the district court, on a theory of unjust enrichment, ordered disgorgement by innocent minors of proceeds from stock held for their benefit under the Uniform Gifts to Minors Act and fraudulently sold on their behalf by a principal defendant.*fn34

Each of these cases focused on the relief defendant's lack of a legitimate claim to the money sought, whether because the relief defendant was a gratuitous beneficiary of the principal defendants' fraud or because he or she merely was the custodian of the principal defendants' assets. Here, however, the Commission wants to seize funds paid as compensation for services actually performed for a principal defendant, albeit paid out of proceeds of the principal defendant's fraud. And that difference — the fact that this defendant performed services for Hanover for which he presumably was entitled to be paid — is significant. It suggests that Aronowitz, in the words of the Commission's cases, has a "legitimate claim" to the money absent proof of culpability on his part.

In other cases in which relief defendants claimed to have earned the money sought, courts have permitted seizure or ordered disgorgement only after determining that the relief defendant in fact had no legitimate claim to the money. In SEC v. Colello,*fn35 for example, the SEC sought to seize the proceeds of a large fraud, including $2.9 million paid to relief defendant Colello. Colello, however, claimed that the money he received was payment for services rendered, namely the procurement of letters of credit for the enterprise.*fn36 The Ninth Circuit approved seizure of Colello's funds after the district court had found that the evidence "`demonstrate[d] the absence of any legitimate call on the funds.'"*fn37 In doing so, the circuit noted the multiple opportunities which the district court had afforded Colello to show some legitimate entitlement to the money.*fn38

No such determination is possible on the record before this Court now. The Commission's 56.1 statement does not allege that Aronowitz knowingly participated in a fraudulent scheme and therefore was enriched unjustly. The issue analytically is the same as on the first of the Commission's arguments — whether Aronowitz had sufficient knowledge of the nature of Hanover's conduct to make his retention of his compensation inequitable. And the Commission's argument fails for the same reason. It has failed to establish the absence of a genuine issue of fact as to Aronowitz's state of mind.


For the reasons set forth above, the Commission's motion for summary judgment as against relief defendant Aronowitz is denied. The Court nevertheless determines, under Fed.R.Civ.P. 56(d), that there is no genuine issue as to any of the facts set forth in the Commission's Statement of Facts Not in Dispute, all of which are deemed established for the purposes of this action. The only remaining issue for trial is whether Aronowitz's mental state makes disgorgement by him appropriate. That issue will be tried to the Court commencing on February 9, 1999 at 9:30 a.m.


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