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U.S. Commodity Futures Trading Commission v. Highland Stone Capital Management, LLC

United States District Court, Second Circuit

August 29, 2013

U.S. COMMODITY FUTURES TRADING COMMISSION, Plaintiff,
v.
HIGHLAND STONE CAPITAL MANAGEMENT, L.L.C., et al., Defendants.

OPINION & ORDER

KATHERINE B. FORREST, District Judge.

Plaintiff U.S. Commodity Futures Trading Commission ("CFTC") filed suit against pro se defendants David Howard, Susan Davis, Joseph Burgos, and several of their corporate entities on July 27, 2011, accusing them of fraudulently soliciting retail investors to trade foreign currency ("forex") through accounts at retail foreign exchange dealers ("RFEDs"). Those accounts were managed by two companies (the "Forex Capital Entities") in which Davis and Howard were officers and directors, Forex Capital Group ("Forex Group" or "FCG") and Forex Capital Trading Partners ("Forex Partners" or "FCP"). The Forex Capital Entities[1] used Burgos's company, Highland Stone Capital Management LLC ("Highland") as their sole forex trader from August 2009 through July 2011.

The CFTC alleges that Howard, Davis, and Burgos were never registered with the CFTC, in violation of provisions of the Commodities Exchange Act ("CEA") and Dodd-Frank Act effective October 2010, and that they intentionally or recklessly made material misstatements and omissions to disguise the fact that Burgos and Highland had a history of losing money in forex trading and continued to do so when trading for customers of the Forex Capital Entities. In sum, the CFTC alleges that defendants' fraud resulted in 106 customers losing $2.86 million from August 2009 through July 2011.

Defendants Davis and Howard argue that they believed Burgos's representations of past forex trading success and were themselves victims of his misrepresentations and omissions. Burgos states that the performance data on which Davis, Howard, and the investors relied was based on hypothetical, rather than actual, accounts - and that Davis and Howard knew or should have known that the accounts were hypothetical.

This Court issued a preliminary injunction against all defendants on February 9, 2012, following a four-day evidentiary hearing. (ECF No. 70.) Defendants moved for partial reconsideration, and the Court modified the preliminary injunction on April 16, 2012. (ECF No. 87.)

Now before the Court is the CFTC's motion for summary judgment as to all of its claims under the CEA against the individual defendants - Burgos, Howard, and Davis. It further seeks a permanent injunction preventing defendants from engaging in future forex trading, disgorgement of over $400, 000 in account fees, and civil penalties.

While the Court finds that Burgos raises no issues of material fact as to the claims against him, triable issues remain with respect to certain claims against Davis and Howard, but not as to others. For the reasons set forth below, the CFTC's motion for summary judgment is GRANTED IN PART and DENIED IN PART.

I. BACKGROUND

The facts recited below are undisputed unless otherwise noted. All favorable inferences are drawn in favor of the nonmovant, pro se defendants.

a. Factual Background

The evidentiary submissions in support of this motion are voluminous, encompassing the results of a wide-ranging CFTC investigation and the record of a four-day preliminary injunction hearing. The Court recites only those undisputed facts necessary to understand the roles of the various parties here and their relevant conduct.

i. Defendants and Related Entities

1 Forex Capital Trading Group, Inc. ("FCG")

Defaulting defendant FCG was a New York corporation that maintained an office at 130 Williams Street, New York, New York. (Pl.'s 56.1 Reply ¶ 1, ECF No. 155.) It was active at the time the CFTC filed this suit, but was never registered with the CFTC in any capacity. (Pl.'s 56.1 ¶ 3, ECF No. 108.)

2. Forex Capital Partners ("FCP")

Defaulting defendant FCP was a New York corporation whose registered address was the same 130 Williams Street address as FCG. (Id. ¶ 2.) Defendant Davis, President of FCP, states that FCP and FCG maintained separate office areas at the Williams Street address. (Aff. of Susan Davis ¶ 1, (Defs. Howard and Davis Response to CFTC R. 56.1 Stmt of Material Facts ("Davis Howard 56.1") Ex. 29, ECF No. 137.) FCP also did business at 50 Broad Street, 75 Broad Street, and 44 Wall Street. (Id. ¶ 4.) FCP was never registered with the CFTC in any capacity. (Id.)

3. Highland Stone Capital Management LLC

Defaulting defendant Highland was a New Jersey Limited Liability Company that conducted business at 50 Broad Street, New York, NY - the same location at which FCP sometimes did business. (Burgos 56.1 ¶ 2.) Defendant Burgos was its sole member. (Id.) It has never been registered with the CFTC in any capacity. (Id.)

4. Susan Davis

Defendant Davis was President and a director of FCG and a signatory on its bank accounts. (Id. ¶ 8.) She was President, Secretary, and a director of FCP and a signatory on its bank accounts as well. (Id. ¶ 9.) Her day to day responsibilities consisted of serving as head of "back office compliance, compliance as it pertained to paperwork[] like applications, " as well as "compliance duties... as far as account opening" (Id.; Pl.'s 56.1 Reply ¶ 30.) At all relevant times, Davis owned either one-third or one-half of outstanding FCP stock. (Davis Howard 56.1 ¶ 9.)

The CFTC alleges that Davis supervised and had the ability to hire and fire the sales agents who solicited customers for the Forex Capital Entities. (Pl.'s 56.1 ¶ 56(a).) It supports this assertion by submitting entries bearing Davis's name on the computer software program "Dashboard", which the Forex Capital Entities used to identify the marketing materials sales agents were sending to prospective customers and to track the agents' contacts for marketing and sales leads. (Pl.'s 56.1 ¶ 56(b).) Davis testified that she merely set up the system and did not author those entries - she notes that the entries bear the initials of supervisory employees who actually entered the data.

The CFTC supports its further assertion that Davis could hire and fire employees with a letter from Davis to sales associate Tanya Dunnaway Jackson dated March 25, 2010, in which Davis informs Jackson that she "will be terminated immediately without further discussion" if she demonstrates continued absences or tardiness. (Letter of Susan Davis to Tanya Jackson, Mar. 25, 2010, Decl. of Joy McCormack ("McCormack Decl.") Ex. 64, ECF No. 107.) Davis responds that she did not possess hiring and firing authority for the sales staff, but rather that she only supervised the administrative staff. (Dep. of Susan Davis ("Davis Dep." at 123:9-14, McCormack Decl. Ex. 5.) She was the signatory to the Jackson letter only because Howard gave her permission to communicate the probation message. (Id. at 53.) Sales agents such as Jackson were independent contractors who were to negotiate their terms of engagement with Howard or one of the other sales executives. (Id.)

Davis registered as an associated person ("AP") of a new commodity trading advisor ("CTA"), Forex Capital Trading Partners NA, Inc., on May, 31, 2011, [2] but was never registered in any other capacity with the CFTC, including in her roles with FCP and FCG. (Id. ¶ 7.)

5. David Howard

Defendant Howard was the CEO, Director of Sales and Marketing, and a Director of FCP. (Davis Howard 56.1 ¶¶ 11, 57(b).) At all relevant times, Howard owned either one-third or one-half of outstanding FCP stock. (Id.) From time to time, Howard revised the sales scripts used by the Forex Capital Entities' agents to solicit prospective customers. (Id. ¶ 57(b).)

The CFTC argues that Howard had the authority to hire and fire sales agents who solicited customers and the authority to enter into financial transactions for the Forex Capital Entities. (Id.; Pl.'s 56.1 ¶ 11.) It presents testimony that Howard interviewed at least one sales staff applicant (Dep. of Nora Matti at 31:11, McCormack Decl. Ex. 10), that the same applicant believed Howard had hiring authority and set marketing goals ( Id., at 55:14-17, 42:6-19), that another sales agent viewed Howard as a supervisor (Brady Dep. at 34:25-36:8, McCormack Decl. Ex. 11), and that he was involved in the decision to place Jackson on probation (Davis Dep. at 52-53).

FCP terminated its relationship with Howard in March 2011 by corporate resolution. (Davis Howard 56.1 ¶ 11.) Howard has never been registered in any capacity with the CFTC. (Davis Howard 56.1 ¶ 10, ECF No. 137.)

6. Joseph Burgos

Defendant Burgos was the sole and managing member of Defendant Highland and held himself out to the public as such. (Burgos 56.1 ¶ 6.) He controlled Highland's bank and trading accounts. (Id.) He has never been registered with the CFTC in any capacity. (Id.)

ii. Burgos's Prior Trading History

Burgos first opened forex trading accounts for Highland in 2008. (Burgos 56.1 ¶ 15.) The CFTC submits its investigator's analysis of accounts held in the name of Burgos or Highland, which concludes that Burgos lost $56, 665 in the forex market between February 2005 and March 2010, constituting 98% of his trading accounts' net deposits. (Pl.'s 56.1 ¶ 16; Pl.'s Mem. of L. Ex. 1 ¶ 60; id. att. 47.) Burgos argues that the investigator's data is mistaken or exaggerated since "the majority of those accounts were sub-accounts under Highland that belonged to prop[prietary] traders that traded their own funds under Highland." (Burgos 56.1 ¶ 16.)

iii. FCG Forex Trading Activities

1 Forex Capital Entities - Highland Agreement

Davis, Howard, and the Forex Capital Entities began to solicit accounts in 2009. To do so, on April 29, 2009, Davis, on behalf of the Forex Capital Entities, entered into an introducing agreement with City Credit Capital ("CCC"), a UK-based forex broker, which then hosted the individual investors' forex trading accounts. (Davis Howard 56.1 ¶¶ 12, 17.) A year later, in June 2010, Davis and Howard, on behalf of the Forex Capital Entities, entered into a similar agreement with Cyprus-based forex broker Windsor Brokers, Ltd. ("Windsor"). (Id. ¶ 18.) The Forex Capital Entities represented themselves as an "introducing broker" ("IB") on their website and in their marketing materials. (McCormack Decl. Att. 21 at HSCM-752-01-00009.)

In August 2009 - between the CCC and Windsor agreements - the Forex Capital Entities entered into an agreement with Burgos to make Highland the exclusive trader of their managed forex accounts. (Id. ¶ 21.)

The Forex Capital Entities solicited individual customers to open retail accounts at CCC or Windsor via unsolicited calls from purchased lists. (Id. ¶ 22.) The independent contractor sales agents making the calls used a handbook provided by the Forex Capital Entities. (Id. ¶ 22.)

Davis and Howard admit that many of the U.S.-based customers solicited to open accounts with CCC or Windsor were not "Eligible Contract Participants" ("ECPs") as defined by the CEA. (Id. ¶¶ 23, 26.) The CEA defines an ECP as an individual whose assets exceed $10 million, or one whose assets exceed $5 million and enters into a forex transaction solely to manage risk. 7 U.S.C. § 1a(18)(A)(xi).

In addition, at least some of the investors who opened accounts signed limited power of attorney authorizations to the Forex Capital Entities. (Id. ¶¶ 12, 19.) However, Highland and Burgos did not hold any POAs for the accounts traded through CCC and Windsor. (Id. ¶ 20.)

2. Marketing Materials

As part of their marketing efforts, the Forex Capital Entities touted Burgos's experience and skill as a forex trader. The Forex Capital Entities' websites quoted a book excerpt that included Burgos as "one of the finest currency traders in the world." (Davis Howard 56.1 ¶ 40.) One of the sales agents, Nora Matti, testified: "[O]ur job was really to promote Joe [Burgos]. Joe is the star of the show and our job was to promote Joe and bring in capital so he could trade in his company." (Dep. of Nora Matti, McCormack Decl. Ex. 10 at 106:8-10.) She summarized that "[t]he whole selling point was that Joe's track record was unparalleled...." (Id. at 72:2-24.)

3. Highland Performance Chart

Critical to the allegations in the CFTC's complaint, Highland and the Forex Capital Entities each posted a Performance Chart to their respective websites, showing a track record of high performance yields for managed accounts from the period 2004-2010. (Davis Howard 56.1 ¶ 36.) Forex Capital Entities sales agents also attached the Performance Chart to follow-up emails to potential customers. (Pl.'s 56.1 ¶ 40; McCormack Decl. Ex. 28 at HSCM XXX-XX-XXXXXX; id. Ex. 43 at HSCM XXX-XX-XXXXXX.) On Highland's web site, Burgos labeled the returns on the Performance Chart as results for "HSC Managed Accounts." Davis updated the Performance Chart monthly - she says merely by copying the results from the Highland site - and posted the results to the Forex Capital Entities' web sites. (Davis Howard 56.1 ¶ 36.)

The CFTC, Davis, and Howard now agree that the Performance Chart is false and does not reflect actual trading data. (Id.) Davis and Howard admit they used the Performance Chart to solicit new accounts, but they argue they only learned the chart was false during the course of the CFTC investigation. (Id.) They assert that Burgos told them the data was for actual accounts. They point to an email where Burgos forwards what purports to be data from a single real account as evidence that he misled them about his past results. (Davis Howard 56.1 ¶ 36; id. Ex. 47 (email).) The email does not mention the Performance Chart.

Davis and Howard admit that, on behalf of the Forex Capital Entities, they considered an outside audit of the Performance Chart data as early as November 2009 and attempted to retain an audit firm, but that no audit was performed. (Davis Howard 56.1 ¶ 42.) Defendants demonstrate that Forex Capital Entities officers emailed several audit and accounting firms in February 2011 to inquire about commissioning an audit of Highland's 2010 returns. (Davis Howard 56.1 Ex. 45.) Davis testified that she eventually hired an audit firm and "fought with [Burgos] ever day to get" the monthly financial statements for 55 Highland-traded accounts necessary for such an audit, but her efforts were unsuccessful. (Davis Howard 56.1 ¶ 42; Prelim. Inj. Hearing ("PI Hearing") at 277:19-24, 506:25-507:4, McCormack Decl. Ex. 4.) She told the Court at the PI hearing that she was so aggressive in seeking the statements that Burgos "wouldn't even return my texts because all he... said... I cared about was getting this audit." (Id.)

Davis testified that she monitored the balances in client accounts, but not on a daily basis. (Davis Dep. at 55-56.) She stated that the clients - not the Forex Capital Entities - received trading statements directly from the RFED every day that a trade executed and that the Forex Capital Entities did not have access to those statements. (Id.) Davis admitted that she could access the account balances, but said she understood it was Highland and Burgos's responsibility to monitor the accounts on a daily basis; Davis's sole job was to do back-end compliance - which she did not define as encompassing compliance with CFTC regulations. (Id.)

Burgos testified that he never represented the data on the Performance Chart as being actual trading results of customer accounts - rather, it displayed the results of "demo" trades or "hypothetical trading" using an algorithm Burgos had created to generate hypothetical accounts. (Id.; Burgos 56.1 ¶ 36.) Burgos admits he knew that the Forex Capital Entities used the Performance Chart to solicit customers and admits he never directly discussed with the Forex Capital Entities that the accounts were hypothetical. (Burgos 56.1 ¶ 36; Testimony of Joseph Burgos at Prelim. Inj. Hearing, Pl.'s 56.1 Ex. 4 at 387.) At the same time, however, Burgos admits he told Davis the results on the Performance Chart "were from actual signal trading". (Burgos 56.1 ¶ 36.) He states that he told "both Davis and Howard on several occasions to stop sending out statements and track records of such signals and rates of return." (Burgos Testimony, PI Hearing at 387.) He alleges that "both Davis and Howard agreed to stop using these materials but then continued to do so." (Id.) Burgos testified that when he worked with a different entity, FXEM, he had included "a disclaimer that said hypothetical trading right under it" but that, once he ceased his association with FXEM, he included the chart on the Highland website but did not include the disclaimer. (Id. at 385-88.) He omitted the disclaimer on Highland's chart because he "wasn't soliciting any clients... and I never have on this [web] page." (Id. at 388.)

4. Sales Solicitation with Performance Chart Data

The Forex Capital Entities sent the Performance Chart data to prospective customers. For example, in March 2010, Howard emailed prospective customer David Todnem with false Highland proprietary account statements showing profitable trading and an alleged "verification" of those statements from a firm called Interbank FX ("IBFX"), for which Burgos had allegedly traded previously. (Pl.'s 56.1 ¶ 49; Davis Howard 56.1 ¶ 49; McCormack Decl. Ex. 39.) A Forex Capital Entities account executive also forwarded "3 verified account statements" assembled by Highland to Todnem on April 15, 2010. (Davis Howard 56.1 Ex. 46 at HSCM-002-15-000008.) Howard sent an email to Todnem on March 19, 2010, in which he wrote:

I have known Joe Burgos for years.... On a professional note, I have witnessed Joe trade with great efficiency and skill for clients over the years and know for a fact that he has long standing relationships with his clients.
* * *
Although I have seen his trading throughout the years, the printable verifiable records are coming from Interbank, the firm he traded through previously. We are awaiting the records from them to be sent to the accountants.
* * *
This by no means we do not verify the records and through speaking with Interbank and the accountants myself, I decided to introduce Joe to FCTP ...

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