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WESTERN CAPITAL DESIGN, LLC v. N.Y. MERCANTILE EXCHANGE

February 16, 2001

WESTERN CAPITAL DESIGN, LLC, PLAINTIFF
v.
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.

Facts

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 ¶ 35.

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.

Discussion

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 pertinent part:

"[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 ...


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