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COMMODITY FUTURES TRADING COMM. v. INT'L FINANCIAL SERV.

May 6, 2004.

COMMODITY FUTURES TRADING COMMISSION, Plaintiff, -v.- INTERNATIONAL FINANCIAL SERVICES (NEW YORK), INC., INTERNATIONAL FINANCIAL SERVICES (NEW YORK), LLC, JOHN WALKER ROBINSON, and CHAN KOW LAI a/k/a WILSON LAI, Defendants, SOCIEDADE COMERCIAL SIU LAP LIMIT ADA, Relief Defendant


The opinion of the court was delivered by: GERARD E. LYNCH, District Judge

OPINION AND ORDER

The Commodity Futures Trading Commission ("Commission" or "CFTC") brought this action under the Commodity Exchange Act ("CEA"), 7 U.S.C. § 1 et seq., as amended by the Commodity Futures Modernization Act of 2000 ("CFMA"), Pub.L. No. 106-554, 114 Stat. 2763, alleging that defendants fraudulently and without authorization engaged in transactions in foreign currency futures contracts. Defendants International Financial Services (New York), Inc. ("LFS Inc.") and Sociedade Comercial Siu Lap Limitada ("Siu Lap"), which purportedly acted as, respectively, brokerage firm and clearinghouse for the orders, defaulted. The Commission now moves for summary judgment against the remaining defendants. It seeks permanently to enjoin them from violating the CEA and to recover, through the remedies of disgorgement, restitution, and statutory penalties, additional funds to compensate the victims of defendants' alleged fraud. Defendant International Financial Services (New York), LLC ("IPS LLC") cross-moves for summary judgment, arguing primarily that the Commission lacks jurisdiction under the Act, but also that EPS LLC cannot be held liable because, contrary to the Commission's allegations, it did not engage in a common enterprise with IPS Inc. Defendant Chan Kow Lai (a/k/a Wilson Lai), an alleged controlling person of IPS Inc., joins in IPS LLC's jurisdictional objections and opposes the Commission's motion on the merits, while defendant John Walker Robinson, former president of EPS Inc., did not oppose the motion. For the reasons that follow, the Commission's motion will be granted and IPS LLC's cross-motion denied.*fn1

  BACKGROUND

  Because IPS Inc. defaulted and both Lai and Robinson invoked their Fifth Amendment privilege against self-incrimination at their depositions, few of the relevant facts can be disputed. Defendants must rely almost exclusively on the Commission's evidence in an effort to establish genuine issues of material fact sufficient to defeat summary judgment. The following recitation of facts is therefore drawn primarily from CFTC's Local Rule 56.1 Statement of Undisputed Material Facts. Alleged factual disputes will be appraised, where relevant, in the course of the discussion below. IFS Inc.

  In 1997, Lai, a controlling shareholder of Frankwell Commodities Limited ("Frankwell"), a Hong Kong company, participated in the establishment of IPS Inc., a New York corporation with offices in Manhattan and Houston, Texas. (P. Rule 56.1 Stmt. ¶¶ 1, 51-52, 58; Kang Decl., Ex. ZZ at 4 & nn.15-17.) IFS Inc. purported to be a currency trading brokerage firm, but it never registered with the Commission. (Id. ¶¶ 2-3.) Lai sat on IFS Inc.'s board of directors and, in that capacity, advised Robinson, its president and chief executive officer. (Id. 34, 54-56.) Robinson oversaw IFS Inc.'s operations, supervised its employees, and handled customer complaints. (Id. ¶¶ 35-38, 41-42.)

  By placing advertisements in the New York Times and foreign-language newspapers read by Chinese, Russian, and Korean immigrants, EPS Inc. recruited persons, whom it characterized as independent contractors ("ICs"), to act as foreign currency brokers, traders, and consultants. (Id. ¶¶ 71-74.) One of these advertisements, for example, which appeared in the Russkaya Reklama, a New York newspaper that caters to the Russian immigrant community, stated:
INTERNATIONAL FINANCIAL SERVICES (NEW YORK) INC[.] American Company from Wall Street with 24 years experience on currency market needs smart, hard-working, energetic people for position as CURRENCY TRADER[.] Two weeks seminar about currency trading, two months paid training, wide opportunity to make money, flexible work schedule.
(Kang Decl., Ex. MM ¶ 4.) The advertisements indicated that applicants need not have prior trading experience, and few ICs hired by IFS Inc. did. (P. Rule 56.1 Stmt. ¶¶ 75-76.)

  IFS Inc. grouped the ICs into divisions based on their ethnicities, which included Korean, Chinese, and Russian, and management encouraged the ICs to solicit customers, including friends and relatives, from their respective ethnic communities. (Id. ¶¶ 74, 78-80; Kang Decl., Ex., LL ¶ 20, Ex. MM ¶ 17.) Management gave the ICs solicitation and training materials, including brochures and scripts for telephone calls, which included a number of misleading or false statements. (P. Rule 56.1 Stmt. ¶¶ 81-82.) IFS Inc. falsely represented, for example, that it maintained "direct links to established networks in the Far East and Southeast Asia, the Middle East, Germany, Switzerland and the United States." (Kang Decl., Ex. OO, Tab 2 at 4; P. Rule 56.1 Stmt. ¶¶ 85-86.) A training manual supplied to the ICs also falsely represented that IFS Inc. executed and cleared currency trades through an affiliate of Frankwell (id. ¶ 86); in fact, Siu Lap, a company with "offices" in an apartment in a residential building in Macao, served as IFS Inc.'s exclusive broker. (Id. ¶¶ 88, 125; Kang Decl., Ex. WW.)

  The solicitation materials, as well as oral representations made by the ICs at the direction or encouragement of IFS Inc.'s management, also misled prospective customers by representing that foreign currency trading offered a very high potential for returns and only a minimal risk of losses. IFS Inc.'s marketing brochure explained that
[t]he main advantage of the FOREX [foreign exchange] market is that there is no bear market as such, in that it is possible to benefit from currency movements whether they increase or decrease in value, so during times of uncertainty and adverse economic conditions the Spot FOREX market offers great opportunity for enhancing portfolio returns.
(Id. ¶ 84.) In a similar vein, IFS Inc.'s sales and marketing manual instructed the ICs to inform prospective customers that making money was the "easy pan" of their job. (Id. ¶ 90.) The same proposed marketing script stated that IFS Inc. would "never exspose [sic] more than 30% of the initial investment. The remaining principal stays in a segregated account at J.P. Morgan." (Kang Decl., Ex. NN, Tab F at 9.) There is no evidence that IFS Inc. even created any client accounts at J.P. Morgan.

  Affidavits from former IFS Inc. customers establish that the ICs routinely misled and lied to customers about the prospect for profits and the status of their accounts. In almost every case, customers lost virtually their entire investments. (P. Rule 56.1 Stmt. ¶¶ 92-102.) One 1C told a customer that she stood to gain as much as 600% on her initial investment. In fact, she lost her entire $40,000 investment. The same customer testified that IFS Inc. representatives did not give her adequate time to read her customer contract, which they characterized as "just a formality." (Kang Decl., Ex. PP ¶ 12.) Someone subsequently forged her initials on the first page of that contract. (Id. ¶ 14.) Another IC, Rene, told a customer, Karahan, that in the "worst-case scenario," he could lose no more than approximately $1000 of his initial $20,000 investment. When Karahan said he would like to take home and review the IFS Inc. contract, Rene told him not to delay, that the contract simply repeated what she had already explained to him, and that in view of favorable market conditions, he should sign it immediately so that she could begin to invest for him. Karahan lost virtually his entire life savings within ten weeks. (Kang Decl., Ex. OO.) Other affidavits from former ICs and customers of IFS Inc. establish that IFS Inc. falsely assured clients that trades would not be made without their express authorization, pressured them to sign account agreements without reading them carefully, refused to permit them to take those agreements out of IFS Inc.'s offices, and transacted with client funds without their authorization. (P. Rule 56.1 Stmt. ¶¶ 96-102.)

  Robinson oversaw the daily operations of IFS Inc., supervised its employees, reviewed client accounts, and bore ultimate responsibility for handling customer complaints. (P. Rule 56.1 Stmt. ¶¶ 41-42, 145-48.) Both IFS Inc.'s ICs and their clients complained to Robinson about the losses caused by IFS Inc.'s trading practices and made him aware that those practices inevitably would cause further losses. (Id. ¶¶ 149, 151-52; Kang Decl., Ex. LL at 9 ¶¶ 27-29.) But the ICs, and ultimately Robinson, would generally respond to customer complaints by telling them to add more money to their accounts. (P. Rule 56.1 Stmt. ¶ 153; Kang Decl., Ex. 00 at 4 ¶ 17; Ex. SS at 3-4 ¶ 11; Ex. MM at 7 ¶ 27.)

  Joseph Merlino, an expert retained by the court-appointed receiver, concluded that, in all, IFS Inc. lost 525,428,840 of the $32,810,454 that it invested for some 820 active customer accounts, or, "[v]iewed another way, a total of S178.89 was lost (risk) for each dollar of profit (reward)." (Kang Decl., Ex. TT at 5-6.) The Commission ascribes these gargantuan losses to the minimal and misguided training that ICs received and to IFS Inc.'s derelict trading practices, which Ezra Zask, an expert for the Commission, thoroughly documented and analyzed. (Kang Decl., Ex. UU ¶¶ 45-51.) New ICs sat through a brief training course in which they learned how to convert the values of foreign currencies into their U.S. dollar equivalents and the history of the foreign exchange market, as well as how to solicit customers, analyze the market (based primarily on charts showing market volatility), and place orders. (Kang Decl., Ex. LL ¶¶ 10-11.) They were also taught a hedging strategy whereby "[i]f a customer has a losing open position, the IC should open an equal, offsetting position in the same currency for the customer instead of closing out the original, losing position to minimize the loss."*fn2 (P. Rule 56.1 Stmt. ¶ 116.) Zask opines that this and other strategies encouraged by IFS Inc., "when executed by underqualified ICs, . . . had the sole effect of diminishing the value of customer accounts while generating commission charges for IFS." (Kang Decl., Ex. UU ¶ 45.) Moreover, because IFS Inc. charged customers "a $90 commission per round-turn transaction," and because the ICs, in turn, "earned commissions based on the number of contract orders placed for customer accounts per month," the ICs had a strong incentive to place orders even when that would be contrary to their clients' interests. (P. Rule 56.1 Stmt. ¶¶ 112-13.) Indeed, Rosen, a former IC, testified that management threatened the ICs with demotion or discharge if they failed to generate adequate commissions for IFS Inc. (Kang Decl., Ex. D at 58.)

  IFS Inc.'s trading procedures also made it virtually impossible for the ICs to make money for their clients. IFS Inc.'s dealing room assistants provided the ICs price quotes for foreign currencies futures contracts, and if the ICs decided to place an order, the assistants would confirm the purchase or sale of the contract with Siu Lap, IFS Inc.'s exclusive "clearinghouse." (P. Rule 56.1 Stmt. ¶¶ 105-06.) Because price quotes for the contracts received from the dealing room consistently differed from the market prices shown on a streaming Reuters ticker board, at times by as many as thirty to forty points, the dealing room quotes often made it impossible for the ICs to make a profit for their customers. (Id. ¶¶ 106-07.) IFS Inc. also severely constrained the freedom of the ICs to place "limit orders," a device that enables traders to mitigate potential losses by placing an order to sell or buy automatically if a particular commodity falls below or exceeds a certain price. (Id. ¶ 109.) This rule compelled the ICs to place "market orders," that is, orders for immediate execution, which would be executed at the unfavorable prices quoted by the dealing room. (Id. ¶ 110.) Based on his analysis of the Commission's evidence, Zask concluded that IFS Inc.'s "structure did not comport to the standards of a legitimate foreign currency firm" and found "no evidence to refute the conclusion that IFS itself reaped the direct losses of the customer accounts, as its own profits." (Kang Decl., Ex. UU at 24 ¶ 61.) In fact, it is not clear that Siu Lap ever executed any of the purported orders placed on behalf of IFS Inc. clients.*fn3 (Id.; see also Kang Decl., Ex. W ¶¶ 78-80.; Ex. NN at 32.)

  In effect, then, IFS Inc. required the ICs to "buy" and "sell" (purported) foreign currency futures contracts at artificially inflated prices provided by IFS Inc.'s dealing room, which, in turn, received its price quotes from Siu Lap, IFS Inc.'s purported clearinghouse. "[T]he exclusive relationship between Siu Lap and IFS left the clients captive to Siu Lap's pricing and rates, and placed the independent contractors and IFS' clients at a great disadvantage." (Kang Decl., Ex. NN at 51.) The ICs, moreover, made money exclusively through commissions generated by the trades, giving them perverse incentives to "buy" and "sell" at prices they knew would result in virtually certain losses for their customers. (Id. 20-28.) And IFS Inc. instructed its ICs to employ "illogical and overly risky" trading strategies that would have been disastrous even had IFS Inc. legitimately been clearing trades through Siu Lap. (Kang Decl., Ex. TT ¶ 45.)

  But the fraud apparently ran even deeper. At bottom. IFS Inc. rigged the market to ensure that, with few exceptions, its customers would lose their money to itself and Siu Lap, to whom, "as a general matter, clients' money was wire-transferred." (Kang Decl., Ex. NN at 17.) Yet no evidence shows "that IFS or . . . Siu Lap . . . had dealing lines or accounts with any participants of the inter-bank foreign currency markets" (Kang Decl., Ex. TT ¶ 41) or "that the foreign currency contracts purportedly purchased and sold by IFS were ever laid off in any foreign currency, futures or inter-bank, market." (Id. ¶ 52.) Hence, "every dollar that was lost by a customer was a dollar gained by IFS" or its partner, Siu Lap. (Id. ¶ 61.) Siu Lap capitalized IFS Inc. and kept it solvent to enable IFS Inc. to continue to solicit client funds to be "invested" with Siu Lap. (Kang Decl, Ex. ZZ at 1-2, 4-6.) According to Merlino's analysis, as summarized by the court-appointed receiver,
IFS' reason for existence was to collect clients' funds, transfer the funds to Siu Lap in Macao, and purposely arrange to "lose" these funds in alleged currency trading. It is unlikely that clients' funds were actually traded. Since IFS and Siu Lap knew that clients' positions would be traded to result in losses, there were possibilities of large and apparently illegal gains to be made (in the amount of the alleged investments). These illegal gains would be made by only reporting the alleged trades on clients' statements, but not actually effecting these trades in the market, and, in the end, simply pocketing the clients' money.
(Id. 9-10.) In short, IFS Inc. apparently accepted thousands of dollars in client funds, issued them statements purportedly showing trading losses, and sent the money to an overseas account holder, Siu Lap, which may well have been no more than an entity that received the stolen funds. (Kang Decl., Exs. WW, ZZ.)*fn4

  IFS LLC

  By letter dated April 6, 2001, Robinson was expressly advised that IFS Inc.'s failure to register with the Commission violated federal law. (Kang Decl, Ex. XX.) On February 12, 2002, Louis F. Burke, counsel for IFS Inc., wrote to the Commission to request that it take no action against IFS Inc. pending a contemplated restructuring and receipt of a decision on its application to register a new entity, IFS LLC, as a futures commission merchant ("FCM"). (P. Rule 56.1 Stmt. ¶ 10; Kang Decl., Ex. F, Tab 2.) The Commission refused to give IFS Inc. a "no action" letter because it failed timely to apply under the relevant laws. (P. Rule 56.1 Stmt. ¶ 6.)

  On March 21, 2002, IFS LLC applied to the Commission to be registered as an FCM. (Kang Decl., Ex. G, Tab 2.) The application form represents that IFS LLC is a New York limited liability company, which maintains offices at 40 Wall Street in Manhattan, where IFS Inc. also has its offices; that IFS LLC's telephone number is the same as that of IFS Inc.; that IFS Inc. is a corporate principal of IFS LLC; and that Johnny Wah Jung, the owner of IFS LLC, is chairman of IFS Inc. (Id. 1, 3.) On page ten of the application form, Jung signed the form as "Chairman" of IFS LLC. (Id. 10.) At his deposition, however, Jung testified that he had never before seen any part of the form except for page ten, and he denied the accuracy of much of the information contained in it, including IFS LLC's address, telephone number, and corporate affiliation to IFS Inc. (Jung Tr. 81-93.) Jung further testified that neither he nor IFS LLC had any business relationship with EFS Inc., Lai or Siu Lap (id. 37, 42, 63), though he conceded that IFS Inc. had deposited a $250,000 check into IFS LLC's bank account to help capitalize his company. (Id. 135-42.)

  The Commission characterizes Jung's deposition testimony as "not credible" (P. Br. 40) and offers substantial documentary evidence to establish that IFS Inc. and IFS LLC engaged in a common enterprise. First, by letter dated February 7, 2002, Robinson, acting for IFS Inc., wrote to E5urke, counsel for IFS Inc., about the company's desire to register with the CFTC. The letter states in relevant part:
At this time we [IFS Inc.] need to establish the following LLC so that we can have the shareholder fund the necessary statutory capital prior to audit for application purposes:
INTERNATIONAL FINANCIAL SERVICE (NEW YORK), LLC
Johnny Jung will inject $250,000 into IFS with the balance of $160,000.00 being invested directly into the LLC. Once the funds are cleared in the IFS account, IFS will transfer the additional $250,000 to the LLC. As a result of the foregoing, Johnny Jung will personally own 100% of IFS and 39% of the LLC and IFS will own the 61% balance of the LLC. . . .[T]he undersigned [Robinson] [will be] the President — Chief Executive Officer of both IFS and the LLC.
(Kang Decl., Ex. H.) Second, an IFS Inc. memorandum dated May 9, 2002, from Jung to Carol C. Poon, an employee of IFS Inc.'s accounting department, and copied to Robinson, states that "effective April 01, 2002, International Financial Services (New York), Inc. will paid [sic] to the undersigned $5,000.00 per month as Chairman/Officer Salary." (Id. Ex. M.) Jung testified that he signed this memorandum, but denied that he wrote or dictated it and asserted that it reflected only IFS Inc.'s tentative offer to him with a view to potential future collaboration between IFS Inc. and IFS LLC. (Jung Tr. 112-24.) Third, two other memoranda, both signed by Jung and written on IFS Inc. letterhead, refer to Jung as "Chairman of the Board," and one refers explicitly to Jung's "recent acquisition of International Financial Services (New York), Inc." (Kang Decl., Ex. M.) Jung conceded that his signature appears on these memoranda, but testified that he does not recall signing them or understand their meaning. (Jung Tr. 125-35.) Fourth, Poon testified that she accompanied Jung to Chase Bank to open an account for IFS LLC because, as she understood it, "he's [Jung] purchasing International Financial Services New York, Inc., and he's opening up an International Financial Services New York, LLC account that is to prepare to meet the new whatever regulations . . . to do business for FOREX trading." (Poon Tr. 275-77.) Finally, the evidence discloses a series of financial transactions among Jung, IFS Inc., IFS LLC, and Siu Lap (P. Rule 56.1 Stmt. ¶¶ 20-23, 27-31; see Kang Decl. Exs. P-S), notwithstanding Jung's insistence that neither he nor IFS LLC had any relationship to IFS Inc. or Siu Lap; indeed, Jung testified that before July 2002, when the Commission brought this action, he had not heard of Siu Lap. (Jung Tr. 157-58.)

  Procedural History

  The Commission filed this action on July 17, 2002. Shortly thereafter, the parties submitted a Consent Order of Preliminary Injunction, which the Court entered as an Order dated August 8, 2002. The Order enjoined defendants from perpetrating certain conduct in violation of the CEA and the Commission's regulations, froze defendants' assets, and appointed a receiver, to whom defendants were directed to surrender those assets. Siu Lap and IFS Inc. defaulted and judgments were entered against them on, respectively, August 19, 2002, and July 7, 2003. The Commission now moves for summary judgment against the remaining defendants.

  DISCUSSION

 I. Standard for Summary Judgment

  Summary judgment must be granted where "there is no genuine issue as to any material fact and . . . the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c). A fact is "material" if it "might affect the outcome of the suit under the governing law"; an issue of fact is genuine where "the evidence is such that a reasonable jury could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). On a motion for summary judgment, the evidence must be viewed in the light most favorable to the nonmoving party, and the Court must resolve all ambiguities and draw all reasonable inferences in its favor. Id. at 255; Cronin v. Aetna Life Ins. Co., 46 F.3d 196, 202 (2d Cir. 1995).

  To defeat summary judgment, however, the nonmoving party "must do more than simply show that there is some metaphysical doubt as to the material facts." Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 586 (1986). "[C]onclusory allegations or unsubstantiated assertions" will not suffice. Scotto v. Almenas, 143 F.3d 105, 114 (2d Cir. 1998). Rather, the nonmoving party must "set forth specific facts showing that there is a genuine issue for trial." Fed.R.Civ.P. 56(e); Matsushita, 475 U.S. at 587 ("Where the record taken as a whole could ...


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