United States District Court, Southern District of New York
February 16, 2001
WESTERN CAPITAL DESIGN, LLC, PLAINTIFF
NEW YORK MERCANTILE EXCHANGE, ET AL., DEFENDANT.
The opinion of the court was delivered by: Hellerstein, District Judge
MEMORANDUM AND ORDER GRANTING DEFENDANT'S MOTION TO DISMISS
This is a complaint for damages under the Commodity Exchange Act and
state law. Plaintiff sues the New York Mercantile Exchange and fifty
unnamed defendants. Defendant NYMEX has moved to dismiss the complaint
pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. For the
reasons stated below, the motion to dismiss is granted.
Plaintiff is a trader of options contracts on the New York Mercantile
Exchange, ("NYMEX"). Plaintiff trades, as others do, through floor
brokers, who are members, but not employees, of NYMEX. NYMEX is the
world's largest commodity exchange for the trading of futures contracts
and options contracts in energy products, metals, and other commodities.
Commodities futures contracts are instruments that allow parties to agree
to buy and sell a particular commodity at a future date. NYMEX provides
facilities as well as an organizational structure for the trading of
commodities futures contracts. All terms of the contract, excepting
price, are set by the exchange. As a contract market, its activities are
regulated by the Commodity Futures Trading Commission ("CFTC"), pursuant
to the Commodity Exchange Act, ("CEA"), 7 U.S.C. § 1, et seq.
The Second Amended Complaint alleges that NYMEX, through its failure in
bad faith to enforce its Floor Rules prohibiting improper trading conduct
and its affirmative allowance of outside trading (described below),
violated the Commodity Exchange Act, 7 U.S.C. § 25, and is liable to
plaintiff for the damage that plaintiff allegedly incurred. Specifically,
the complaint alleges that plaintiff was required to pay floor brokers
for transactions in heating oil options contracts and natural gas options
contracts, "at premiums outside the current market price that differ so
far from a consistent pricing model and from other option orders executed
contemporaneously by NYMEX option floor brokers as to be explainable only
by a pattern of fraud by the NYMEX option floor brokers." Complaint at
The complaint refers to these transactions as "outside contracts," and
alleges that NYMEX, by failing to disallow them, violated NYMEX Floor
Rule 6.06(A), which states, in pertinent part
Transactions made on the Exchange trading floor at a
price above that at which such futures or options
contract is bid, are not made at the current market
price for such futures or options contracts and shall
be disallowed by any floor official designated by the
President or by any member of the Floor Committee. If
so disallowed, such transactions shall not be reported
or recorded by the Exchange.
Complaint at ¶ 34. The Complaint alleges that NYMEX fraudulently
misled the public by representing that it enforces its rules and
regulations that it causes to be distributed to the public, and
accordingly offers a safe, fair and orderly market protected by rigorous
financial standards and surveillance procedures, while all the while
tolerating trading of these Rule-violative outside contracts. Complaint
at ¶ 66-71.
The complaint states four claims for relief: a claim alleging
violations of the Commodity Exchange Act, a claim of common law fraud, a
claim concerning the breach of
the broker's duty of best execution, and a
claim for breach of fiduciary duty. NYMEX moved to dismiss the first
count of the complaint on the grounds that the complaint failed
adequately to plead bad faith, as required in an action filed under the
Commodity Exchange Act. NYMEX also moved to dismiss counts two through
four of the complaint on the grounds of preemption, failure to plead
fraud with specificity, and lack of a fiduciary relationship between the
The first cause of action is brought under the Commodity Exchange Act,
7 U.S.C. § 1, et seq. Section 22(b)(1)(A) of the CEA states, in
"[A] contract market [such as NYMEX] . . . that fails
to enforce any bylaw, rule, regulation or resolution
that it is required to enforce by Section 5a(8) and
5a(9) [7 U.S.C. § 7a(8) and 7a(9)] . . . of this
Act . . . shall be liable for actual damages sustained
by a person who engaged in any transaction on or
subject to the rules of such contract market . . . to
the extent of such person's actual losses that
resulted from such transaction and were caused by such
failure to enforce . . . such bylaws, rules,
regulations or resolutions."
7 U.S.C. § 25(b)(1).
Bad faith is a necessary element to sustain a private right of action
against an exchange under the CEA. See 7 U.S.C. § 25(b)(4) (a victim
must establish that the contract market "acted in bad faith in failing to
take action or in taking such action as was taken" which supposedly
caused the loss for which the plaintiff is suing.) This requirement is
strictly applied. See, e.g., Ryder Energy Distribution Corp. v. Merrill
Lynch Commodities, Inc., 748 F.2d 774, 780 (2d Cir. 1984) ("[T]he failure
of an Exchange to enforce its rules may provide a cause of action. To
avoid dismissal, however, a complaint must adequately plead bad faith on
the part of the Exchange. Moreover, we have recently made it clear that
the bad faith requirement governs claims of both Exchange action and
inaction. [Citation omitted]").
The conduct complained of in this case implicates the Exchange's
performance of its statutory duty to maintain a fair and orderly market.
An adequately pleaded charge of bad faith is essential. Apex Oil Co. v.
DiMauro, 641 F. Supp. 1246, 1282 (S.D.N.Y. 1986) (Walker, J.) (quoting
P.J. Taggares Co. v. New York Mercantile Exchange, 476 F. Supp. 72, 78
(S.D.N.Y. 1979) (Weinfeld, J.)).
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 (1987); Jordan 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 (2nd Cir. 1984).
The second amended complaint alleges that NYMEX was aware, through its
monitoring activities, of the alleged violations of its floor rule that
prohibits outside trading. The complaint then alleges that NYMEX
advertised its rules and its active enforcement to induce the public to
trade, even though it knew that it was doing nothing to prevent outside
trading.2d Am. Compl., ¶¶ 65-76. As motive, plaintiff alleges
that the officers and governing board members
ultimately charged with enforcement of the applicable
Floor Rules are or may be among the Doe Defendants and
thus do not wish to enforce prohibitions that would
limit their ability to conduct outside trades.
Complaint ¶ 75. Thus, plaintiff alleges improper motive, that is, bad
faith, on the part of the Exchange on the basis of speculative
allegations. That is not sufficient to satisfy the special pleading rule
of Ryder Energy.
Plaintiff, arguing for legal sufficiency, claims that it has alleged
gross indifference to enforcing its floor rules governing outside
trading, and that there can be only two possible explanations: an
indifference to its duties to regulate its own activities and those of
its members constituting a bad faith abuse of the discretion given to
NYMEX by the CEA, see complaint ¶ 74; or self interest, as reflected
in the speculative allegations of paragraph 75 of the complaint.
However, there is a third explanation suggested by plaintiff's factual
allegations, and that is negligent inattention. Plaintiff's allegation of
indifferent monitoring is mere hyperbole — an effort to substitute
rhetoric for the obligation to plead bad faith by specific facts. No
specific facts have been pleaded to support the claim that NYMEX acted out
of "self-interest or other motive unrelated to proper regulatory
concerns" in its enforcement activities. See Sam Wong & Son, Inc. v. New
York Mercantile Exchange, 735 F.2d 653, 677 (2nd Cir. 1984). Negligence
does not constitute bad faith. Brawer, 807 F.2d at 302.
Plaintiff alleges that unnamed officers or directors of NYMEX failed to
prevent outside trades due to a bad-faith desire to profit from them as
floor traders.2d Am. Compl. ¶ 75. But officers cannot be traders.
See Floor Rules 2.00(c), 2.20 and 6.31A. And there is no allegation that
such unnamed, and presumably unknown, officers controlled NYMEX or
influenced its conduct. The allegation is pure speculation, insufficient
to satisfy the rule of pleading bad faith by specific facts. Ryder
Energy, supra; M.C. Silberberg, Civil Practice in the Southern District
of New York § 6.09 at 6-20-22 (2d ed. (1999).
Accordingly, the motion to dismiss Count one of the Second Amended
Complaint is granted. Since plaintiff has previously amended and does not
appear to have the ability to plead a legally sufficient claim, Count one
is dismissed with prejudice.
Defendant NYMEX' motion to dismiss also addresses the inadequacy of the
remaining counts. As to count two, common law fraud, plaintiff alleges
that "by concealing and failing to disclose that not all market trades
would be executed in accordance with its Floor Rules, . . . [NYMEX]
committed fraud in violation of the common law of New York." 2d Am.
Compl. ¶ 81. Defendant NYMEX moves to dismiss, arguing that plaintiff
has failed sufficiently to allege the requisite mental state (scienter)
to sustain an allegation of fraud and that the state law claim is
The failure to plead specifically noted for Count one applies
as well to the scienter requirement of Count two. It, too, must be
dismissed. But it is also pre-empted by federal law.
The Commodity Exchange Act itself does not contain an express statement
of preemption. See 7 U.S.C. § 1, et seq. Defendant argues that since
Congress intended to supply a uniform set of regulations for the
commodities markets, allowing a state law claim of fraud to proceed, on a
theory that an Exchange failed in its duties to enforce its rules as
required under the CEA, would frustrate this intent. Plaintiff counters
by arguing that its claim does not concern the manner in which the
Exchange conducts its business. Rather, plaintiff maintains, count two
rests on an allegation that NYMEX affirmatively misrepresented itself to
the public, and was indifferent to its representations, thus committing
fraud. The plaintiff argues that curing this harm would not require the
Court even to consider the rules concerning commodity market regulation
as mandated by the CEA.
The parties appear to agree that a claim under state law that
implicates NYMEX's duties to self-police and regulate as required under
the Commodity Exchange Act is pre-empted. A claim that lies not on
separate and distinct duties established under the common law, but rather
in an Exchange's representations about its federal statutory duties, is
not a separate and distinct claim. See American Agric. Movement, Inc. v.
Board of Trade, 977 F.2d 1147, 1154-57 (7th Cir. 1992) (ruling that the
Commodity Exchange Act preempts state law claims that "bear  upon the
actual operation of the commodity futures markets"), cited with approval
in Barbara v. New York Stock Exchange, Inc., 99 F.3d 49, 59 (2d. Cir.
1996). Accordingly, the motion to dismiss count two of the complaint is
NYMEX also moves to dismiss count three, breach of the broker's duty of
best execution, and count four, breach of fiduciary duty, on the grounds
that these claims are directed towards the relationship of the plaintiff
to his broker or brokers, and not to NYMEX. I agree. Count three states
clearly that it is directed to a broker's duty, not an Exchange's duty,
and count four is based on the fiduciary relationship that exists between
a broker and his client, not between a market and a trader. The plaintiff
appears to agree as well, for these issues were not briefed in its
opposition papers. Accordingly, counts three and four of the complaint are
dismissed against NYMEX.
For the reasons discussed above, Defendant NYMEX's motion to dismiss is
granted. Accordingly, the Second Amended Complaint is dismissed as
against NYMEX, and the Clerk may enter judgment in its favor. Plaintiff
has named no other defendant, and the Second Amended Complaint may not
stand against only unnamed, unserved defendants. When only unserved
defendants remain in a case, a court may enter final judgment "since
there is no basis for believing there will be any further adjudications
in the action, or . . . for holding the dismissals subject to revision."
Leonhard v. United States, 633 F.2d 599, 608 (2d Cir. 1980).
Accordingly, the Second Amended Complaint is dismissed entirely, without
leave to re-plead.
The Clerk shall mark the case as Closed.
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