Commodity Futures Trading Commission, Cross v. Anthony Vartuli, Defendant-Appellant-Cross-Appellee, Avco Financial Corp., J. Michael Gent
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Full Opinion
VAN GRAAFEILAND, Circuit Judge, concurs in Parts I and IV and concurs in the result as to Parts II and III.
The Commodity Futures Trading Commission (the “Commission” or the “CFTC”), an independent federal regulatory agency charged with the administration and enforcement of the Commodity Exchange Act, 7 U.S.C. §§ 1 et seq. (the “CEA”), and the regulations promulgated thereunder, 17 C.F.R. §§ 1.1 et seq., brought a civil enforcement action in the United States District Court for the Southern District of New York against defendants AVCO Financial Corp., Anthony Vartuli and J. Michael Gent. In its complaint, the Commission claimed that the defendants had violated the CEA by man
Subsequent to the commencement of the Commission’s enforcement action, AVCO filed a voluntary petition in bankruptcy. The district court (John F. Keenan, Judge) ruled, however, that the bankruptcy filing did not stay the Commission’s action because the Commission was seeking to enforce its regulatory power and the action was therefore exempt from the automatic stay under 11 U.S.C. § 362(b)(4). See CFTC v. Avco Fin. Corp., 979 F.Supp. 232, 235 (S.D.N.Y.1997) (“Avco I ”). When AVCO nevertheless failed to appear, a default judgment was entered against it. The district court then conducted a bench trial — which, pursuant to Fed.R.Civ.P. 55(b)(2), was in the form of an inquest as to AVCO because of its default — in order to make the findings of fact and conclusions of law necessary to determine whether and to what extent to impose injunctive relief against the defendants and to determine appropriate ancillary relief, if any. After trial, the district court entered judgment against AVCO and Vartuli on all three counts of the Commission’s complaint. See CFTC v. Avco Fin. Corp., 28 F.Supp.2d 104, 122 (S.D.N.Y.1998) (“Avco II ”). The complaint against Gent was dismissed in its entirety. See id. The court issued a permanent injunction against AVCO and Vartuli and ordered the disgorgement of the profits that they had garnered from the sale of Recurrence. See id. at 120-21. Vartuli appealed. The Commission cross-appealed on the issue of the size of the disgorgement award.
Because we agree that AVCO and Var-tuli violated the CEA, we affirm the district court’s holding to that effect, although on somewhat different grounds. Because the conduct enjoined by the district court included the dissemination of Recurrence as speech and the district court did not first engage in prior restraint analysis, however, we conclude that the injunctive relief granted by the district court is in part unconstitutional, and to that extent we reverse and remand for the injunction to be modified. On remand we also direct the district court to determine whether an issue identified in Part II of this opinion, below, relating to whether customers of AVCO were “clients” under the applicable statutory language, was raised before it, and, if it was, to decide that issue in the first instance. We affirm the award of disgorgement.
BACKGROUND
The facts relating to this appeal, which are not substantially in dispute, are described extensively in Avco II. In brief, the defendant Anthony Vartuli incorporated the Taurus Group, later renamed AVCO Financial Corp., in 1987. AVCO’s corporate purpose, according to its certificate of incorporation, was “to provide investment advice in stocks, options and commodities.” In 1989 AVCO, of which Vartuli was the sole shareholder, began marketing a set of materials called the “Recurrence” system, which Vartuli had developed with defendant Gent. Five versions of Recurrence were eventually produced (Recurrence IV), the first two in book form and the latter three as computer software on disk. In this appeal, we are concerned principally with the computerized versions.
AVCO told its customers to obtain a market reporting service to feed current market prices for Swiss franc future contracts (or, for Recurrence V, Japanese yen future contracts) into a computer loaded with the Recurrence program. Recurrence would then analyze the transactions taking place in the futures market and give the user instantaneous “buy” or “sell” signals. AVCO claimed that following these signals would enable Recurrence
The Defendants’ customers pay AVCO’s licensing fee, and, if they wish to follow the instructions given by the Defendants’ system themselves, install the Defendants’ computer program on their personal computers, procure a market reporting service to feed current market prices to the computer, and then act on the instructions given by the Defendants’ system.
In addition to selling the system, AVCO gave occasional supplemental advice to Recurrence users by telephone. It also provided customers with a list of “authorized brokers” who were willing to trade for the account of an AVCO customer using the Recurrence system if the purchaser of the system did not want to order each specific transaction him or herself.
AVCO advertised the Recurrence system, which sold for prices ranging from $1500 for Recurrence I to $4500 for Recurrence IV, extensively. The advertising made clear that Recurrence was being sold as a system for trading commodities futures, and that for the system to function properly its commands were to be followed explicitly. A Recurrence ad run in the 1995 Partnership Packet, for example, said:
“You’ll be advised on what pattern is present, at what price to buy or sell, at what price to place your protective stop, and where to take profits.... All the trader needs to do is call [his or her] broker and place the appropriate trades.”
Recurrence also told potential purchasers:
[Recurrence’s] message gives you a specific buy or sell recommendation, as well as a specific stop and profit objective. You just call your broker and give the complete order (you can even read the instructions right off your screen) and then sit back and watch as Recurrence monitors the market and your position in real time.
(Emphasis in original.) An ad run in multiple editions of Futures Magazine informed prospective customers that they must “follow the signals with no second-guessing.” And an advertisement that appeared in various editions of various publications warned that a Recurrence customer had to be possessed of a “lack of ego” in order for him or her to “begin taking profits immediately.”
From 1991 to 1997, AVCO’s advertisements for the Recurrence system claimed some remarkable results. AVCO advertised that “Recurrence III makes money automatically,” “the system turned a $10,000 trading account into a $544,704 fortune-a return of 833% per year,” and, “If you’re serious about making money trading the markets, see the enclosed verified performance summary showing how Recurrence IV turned $2,500 into well over $130,000 trading only one Swiss Franc futures contract.” But AVCO’s claims were based on computer-generated hypothetical use of the system rather than actual trades, a fact not disclosed in the advertisements.
In addition to mass-media advertisements, AVCO also sent promotional materials to prospective customers. The order form that accompanied these materials contained a disclaimer that began:
CFTC Disclosure: While the numbers used in this literature are “Real Time Data” the CFTC requires the following disclaimer on all market related literature. . Hypothetical or Simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading.
(Emphasis in the original.)
AVCO’s advertisements were successful. Total revenue from sales of the system grew to more than four million dollars.
The results of actual trading using the Recurrence system did not live up to AVCO’s promotional claims. The district
The Commission filed a three-count complaint against AVCO, Vartuli and Gent. Count I charged the defendants with solicitation fraud in violation of Section 4b(a)(i) of the CEA, 7 U.S.C. § 6b(a)(i). Count II charged the defendants with fraud by a commodity trading advisor (“CTA”) and fraudulent advertising under Section 4o (1) of the CEA, 7 U.S.C. § 6o (1). Count III charged the defendants with having failed to register AVCO as a CTA as required by Section 4m(l) of the CEA, 7 U.S.C. § 6m(l). The complaint charged Vartuli and Gent both as controlling persons of AVCO and as aiders and abettors of AVCO’s conduct with respect to each count.
Employing a preponderance of the evidence standard, the district court found against AVCO and Vartuli on all three counts. See AVCO II, 28 F.Supp.2d at 115-20. The court dismissed all of the charges against Gent on the ground that he was not responsible for the false and misleading claims or the other actions with which AVCO was charged. See id.
On Count I, the court found that AVCO’s representations about the Recurrence system’s level of risk and past performance were material, false, misleading, and made with scienter. See id. at 115-18. While the defendants maintained that the basis for their performance claims were legitimate “hypothetical” trading models, the district court found that AVCO customers reasonably believed that the statistics provided in the Recurrence advertisements referred to the results of actual trades and as such were false and misleading. Id. at 115-16. The court also concluded that those representations were made in connection with futures trading. See id. at 116-17. AVCO and Vartuli were held directly liable for the representations, and Vartuli was also held liable as a controlling person of AVCO and as an aider and abettor. See id. at 117-18.
On Count II, the court determined that AVCO was in fact a CTA even though it had never registered as one, and that AVCO’s actions were therefore subject to the regulations governing CTA conduct. See id. at 118-19. The court then concluded that AVCO had employed “devices, schemes or artifices to defraud” and “practices or courses of business which operate as a fraud or deceit upon” its customers in violation of 7 U.S.C. § 6o (1) and 17 C.F.R. § 4.41(a). Id. at 119. It further held that AVCO had failed to accompany the hypothetical performance statistics used in its promotional materials with the warning required by 17 C.F.R. § 4.41(b). See id. Vartuli was again held liable as a controlling person and as an aider and abettor. See id. at 120.
Because the district court concluded that AVCO was a CTA and AVCO concededly never registered with the Commission, the district court held that AVCO was hable on Count III, failure to register as a CTA. See id. Once again, Vartuli was held hable as a controlling person and as an aider and abettor. See id.
After entering judgment against them, the court permanently enjoined AVCO and Vartuli from acting as CTAs, trading in commodities, and soliciting customers for commodities trading. See id. at 120-21. AVCO and Vartuli were originally held to be jointly and severally liable for disgorgement in the amount of $4,148,572, the gross revenue received by the defendants for the sale of Recurrence. See id. at 121. The award was later reduced to $701,534 to reflect only the defendants’ net income on such sales. See CFTC v. Avco Financial Corp., No. 97 CIV. 3119(JFK), 1998 WL 524901, at *1, 1998 U.S. Dist. LEXIS
On appeal, Vartuli argues that the misrepresentations made by AVCO were not made “in connection with” the purchase or sale of commodity futures contracts and were therefore not covered by the anti-fraud provisions of the CEA; that a software publisher such as AVCO does not fall within the statutory definition of a CTA; that if software publishers are CTAs then the CEA licensing scheme violates the First Amendment; that AVCO’s customers were not “clients” covered by 7 U.S.C. § 6o (1) and that in any case they were provided with the disclosure language specified in Regulation 4.41 under the CEA; and that Regulation 4.41 unconstitutionally compels speech. He does not dispute his liability as a controlling person of AVCO or as an aider and abettor; we therefore do not address Vartuli’s and AVCO’s actions, or liability, separately. See Guttman v. CFTC, 197 F.3d 33, 39-40 (2d Cir.1999) (discussing vicarious liability under the CEA); Cuoco v. Moritsugu, 222 F.3d 99, 112 n. 4 (2d Cir.2000) (issues not sufficiently raised in the briefs will normally not be addressed by this Court on appeal).
DISCUSSION
We review the district court’s findings of fact for clear error, and its conclusions of law de novo. See, e.g., Counihan v. Allstate Ins. Co., 194 F.3d 357, 360 (2d Cir.1999).
I. Count I: Solicitation Fraud
Count I of the Commission’s complaint against the defendants charged them with committing commodities fraud in violation of Section 4b(a)(i) of the CEA, 7 U.S.C. § 6b(a)(i). Section 6b(a) makes it unlawful “for any person, in or in connection with any order to make, or the making of, any contract of sale of any commodity for future delivery, made, or to be made, for or on behalf of any other person ... (i) to cheat or defraud or attempt to cheat or defraud such other person.” Id.
Vartuli argues that the district court erred in holding the defendants liable for commodities fraud under § 6b because any misrepresentations that were made in the advertising for Recurrence were made in connection with AVCO’s sale of its software, not in connection with transactions in commodity futures engaged in by AVCO customers. We find this argument unpersuasive.
“By its terms, Section [6]b is not restricted ... to instances of fraud or deceit ‘in’ orders to make or the making of contracts. Rather, Section [6]b encompasses conduct ‘in or in connection with’ futures transactions. The plain meaning of such broad language cannot be ignored.” Saxe v. E.F. Hutton & Co., 789 F.2d 105, 110-11 (2d Cir.1986) (ellipsis in original) (quoting Hirk v. Agri-Research Council, Inc., 561 F.2d 96, 103-04 (7th Cir.1977)). And liability under § 6b explicitly extends beyond “member[s] of the contract market” to “any person” engaging in conduct “in connection with” futures transactions. 7 U.S.C. § 6b(a); Saxe, 789 F.2d at 111.
Recurrence was sold by the defendants as a system for trading in futures contracts, a “currency trading system.” The purpose and function of the software was to advise users what futures transactions to execute. AVCO implored users to “follow” signals from Recurrence “with no second-guessing.” Purchasers of Recurrence were instructed by the defendants to undertake specific transactions entirely in reliance on it. Thousands of such transactions were in fact undertaken. Misrepresentations about Recurrence, the way it functioned, the risks involved in using it, and the results it would produce were necessarily misrepresentations about all the trades directed by the Recurrence system. The intended and direct link between the advertisements and the currency trading rendered any misrepresentations in the advertising “in connection with” the suggested futures transactions.
The connection between the asserted misrepresentations and the trading seems to us to be, if anything, clearer here than in Saxe. The misrepresentations in AVCO’s advertisements directly reflected on the reliability of the suggestions made by Recurrence about specific futures trades, whereas in Saxe the misrepresentation concerned a broker who in turn made independent recommendations about commodity transactions.
The Fifth Circuit recently affirmed a CFTC ruling similar to the district court’s in the case at bar. The case began as an administrative enforcement action brought by the Commission against a seller of software bearing a striking resemblance to Recurrence. See R & W Technical Servs. Ltd. v. CFTC, 205 F.3d 165, 173 n. 35 (5th Cir.2000) (“R & W”) (referring to the misrepresentations as found by the district court in Avco II as “nearly identical” to the misrepresentations in the sale of software in the case before the court). The court deferred to the CFTC’s view in the administrative proceedings, id. at 173, and therefore adopted the CFTC’s “not unreasonable” contention that advice is “in connection with” futures trading if it “relates to the risk of the trading and the primary purpose of purchasing the advice is to execute trades,” id. Because the “expensive software [at issue] had no purpose except as a device for choosing which trades to make,” fraud in the sale of that software was fraud “in connection with” commodities futures transactions. Id. at 172-73. The same is true here.
We therefore affirm the district court’s finding that AVCO’s representations about the Recurrence system were made in connection with futures trading. And because the statements that AVCO made about Recurrence were false, misleading and made with scienter — findings that are not in dispute on appeal — we hold that the defendants’ conduct violated § 4b(a)(i) of the CEA, 7 U.S.C. § 6(b)(a)(i).
II. Count II: Fraud by a Commodity Trading Advisor
A. Statutory and Regulatory Framework.
Count II of the complaint alleges that AVCO violated § 4o (1) of the CEA, 7 U.S.C. § 6o(l), and Commission Rules 4.41(a) and (b), 17 C.F.R. § 4.41(a)-(b). Section 6o(l) makes it unlawful for CTAs or their associates:
(A) to employ any device, scheme, or artifice to defraud any client or participant or prospective client or participant; or
(B) to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or participant or prospective client or participant.
Vartuli argues that AVCO cannot have violated § 60 (1) and Regulation 4.41(a) because those provisions apply only to CTAs, and AVCO does not meet the statutory definition of a CTA. He further argues that we could not conclude that AVCO is a CTA without rendering the CEA unconstitutional because the act contains a provision requiring all CTAs to register. Var-tuli asserts that this registration provision, if applicable to AVCO, violates the First Amendment.
We conclude that AVCO meets the statutory definition of a CTA and affirm the. district court’s holding that AVCO violated the fraud provisions applicable to CTAs. Those provisions apply to CTAs irrespective of whether they are “exempt from registration under the Act,” 17 C.F.R. § 4.41(c)(2), so the question of whether the CEA’s registration requirement would be unconstitutional as applied to AVCO is independent from the question of whether AVCO is a CTA for purposes of the remainder of the Act, including 7 U.S.C. § 6o (1). Cf. New York Currency Research Corp. v. CFTC, 180 F.3d 83, 89 (2d Cir.1999) (holding that registering as a CTA and acting as a CTA are independent requirements, both of which must be met for certain provisions of the CEA to apply). We address the constitutional issues particular to the antifraud provisions of § 6o (1) and Regulation 4.41 in Section E, below, and separately discuss the registration requirement in Part III.
B. AVCO is a Commodity Trading Ad-visor
A CTA is defined in § la(5)(A) of the CEA, 7 U.S.C. § la(5)(A).
[T]he term “commodity trading advisor” means any person who-
(1) for compensation or profit, engages in the business of advising others, either directly or through publications, writings, or electronic media, as to the value of or the advisability of trading in—
(I) any contract of sale of a commodity for future delivery made or to be made on or subject to the rules of a contract market; ... or
(ii) for compensation or profit, and as part of a regular business, issues or promulgates analyses or reports concerning any of the activities referred to in clause (i).
Sections la(5)(B) and (C) combine to exclude certain classes of people and entities from this definition, however. Relevant for our purposes, they exclude both “any news reporter, news columnist, or news editor of the print or electronic media,” § la(5)(B)(ii), and “the publisher or producer of any print or electronic data of general and regular dissemination, including its employees,” § la(5)(B)(iv), provided that “the furnishing of such [advisory services as described in § la(5)(A) ] ... is solely incidental to the conduct of their business or profession,” § la(5)(C).
There is no dispute that as the district court found, AVCO advised others through the electronic media, for profit, as to “the value or the advisability of trading in” futures contracts for Swiss francs and Japanese yen. Avco II, 28 F.Supp.2d at 118. “Throughout the day, in response to market conditions, Recurrence provided specific buy, sell, stop and profit objective recommendations to customers.” Id. AVCO therefore falls within the primary definition of a CTA: It engaged in the business of advising others, through Recurrence, as to the value or the advisability of trading in futures contracts, i.e., it told customers whether to buy or sell yen or Swiss franc futures.
The question thus becomes whether AVCO fits within the relevant CEA exclusions from the definition of
Vartuli relies on Lowe v. SEC, 472 U.S. 181, 105 S.Ct. 2557, 86 L.Ed.2d 130 (1985), to argue that one of the exclusions must nonetheless apply. In Lowe, the Securities and Exchange Commission attempted to enjoin the defendant, a former investment adviser whose license had been revoked for criminal misconduct, from publishing a semimonthly newsletter containing investment advice and commentary. The defendant argued that the SEC could not force it to register in order to publish its newsletter because the registration provision of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-3(c), only applied to “investment advisers,” and the definition of “investment adviser” specifically excluded “the publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation.” Id. at 203-04, 105 S.Ct. 2557.
After an extended analysis of the legislative history of the relevant provisions of the Investment Advisers Act, the Supreme Court concluded that it was required to interpret them “to keep the Act free of constitutional infirmities.” Id. at 207, 105 S.Ct. 2557. The Court therefore read the Investment Advisers Act’s exclusion from registration to cover the defendant, and thereby avoided the question of whether the registration provisions constituted an unconstitutional prior restraint on speech. Id. at 204-05, 105 S.Ct. 2557.
As long as the communications between petitioners and their subscribers remain entirely impersonal and do not develop into the kind of fiduciary, person-to-person relationships that were discussed at length in the legislative history of the Act and that are characteristic of investment adviser-client relationships, we believe the publications are, at least presumptively, within the exclusion and thus not subject to registration under the Act.
Lowe, 472 U.S. at 210, 105 S.Ct. 2557.
Because the Lowe court, in order to avoid the First Amendment issue, read the Investment Advisers Act’s registration provision to apply only to personalized communications, Vartuli would have us read Lowe to state, by implication, that we must construe the CEA’s general definition of CTA to include only those who engage in personalized communications. To do otherwise, he argues, would render the CEA, or at least its registration provision (which we address separately in Section III), unconstitutional.
But Lowe was decided on the basis of the language and history of the Investment Advisers Act. The Lowe court, although interpreting the language of the Act in light of principles of constitutional law with which the drafters of the Act would have presumably been familiar, see id. at 204, 105 S.Ct. 2557, pointedly refused to reach the constitutional question, see id. at 211, 105 S.Ct. 2557. Thus Lowe provides us with neither a binding inter
We are thus left where we began, with the statutory language of the CEA. First, to fit within the exclusion, AVCO’s data had to be “of general and regular dissemination.” 7 U.S.C. § la (5)(B)(v). As the Fifth Circuit pointed out in R & W, the recommendations provided by software such as Recurrence are not “of general and regular dissemination” because, as the Supreme Court reasoned when analyzing the identical phrase in the Investment Advisers Act, regular dissemination requires that there be
“... no indication that [dissemination] ha[s] been timed to specific market activity.” In this case, the petitioners’ recommendations were provided by software that was programmed to “speak” only when certain market conditions were met. Thus, the petitioners’ recommendations were timed to particular market activity and not “regularly” disseminated.
R & W, 205 F.3d at 174-75 (quoting Lowe, 472 U.S. at 209, 105 S.Ct. 2557) (brackets in original; footnote omitted). The Fifth Circuit’s observation about R&W and its product is fully applicable to AVCO,'Vartu-li and Recurrence.
Second, whereas the Investment Advisers Act excluded from its registration requirement “the publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation,” the CEA exclusion from its definition of a CTA applies to publishers and disseminators of information only if “the furnishing of such services ... is solely incidental to the conduct of their business or profession.” § la(5)(C). See Commodity Trend Serv. v. CFTC, 149 F.3d 679, 689 (7th Cir.1998) (financial publisher similar to the plaintiff in Lowe “plainly falls within the definition of a ‘commodity trading advisor’.... The only question ... is whether [its publishing] activities are ‘solely incidental’ to its business.”). The publishing of Recurrence was AVCO’s primary business. The exclusion therefore does not cover AVCO, and for purposes of Count II of the complaint AVCO was a CTA.
C. Fraud by a CTA Under 7 U.S.C. § 6o(l) and 17 C.F.R. § kM(a)
We thus agree with the district court that AVCO acted as a CTA, and on appeal Vartuli does not dispute that AVCO’s conduct was fraudulent. He argues, however, that AVCO did not violate 7 U.S.C. § 6o (1) and 17 C.F.R. § 4.41(a) because those provisions apply only to frauds committed by a CTA upon a “client or participant or prospective client or participant.” 7 U.S.C. § 6o (1)(A); 17 C.F.R. § 4.41(a)(1). Purchasers of Recurrence were clearly not participants or prospective participants in a commodity pool; Vartuli argues that they also were not “client[s]” of AVCO.
As the R&W court observed, the issue is not free from doubt. See R & W, 205
The R & W court never reached this issue, however, because the R & W petitioners failed to raise it during the agency proceedings from which appeal was being taken. Id. We find ourselves in much the same situation. The Commission has suggested to us that the issue was not raised in the district court, and Vartuli has not established that it was. The Commission’s suggestion, moreover, is strongly supported by the treatment of the concept of “client” by the district court in Avco II. The court simply replaced the word “client” with “customer” when discussing the statute, giving the impression that the distinction between the two words and its significance had not been argued before it. See Avco II, 28 F.Supp.2d at 119.
The district court was right to ignore the issue if it was not litigated before the court. See Acosta v. Artuz, 221 F.3d 117, 122 (2d Cir.2000). And “[i]t is a well-established general rule that an appellate court will not consider an issue raised for the first time on appeal.” Maska U.S., Inc. v. Kansa General Ins. Co., 198 F.3d 74, 79-80 (2d Cir.1999) (citation and internal quotation mark omitted). See also Gurary v. Winehouse, 190 F.3d 37, 44 (2d Cir.1999) (“Having failed to make the present argument to the district court, plaintiff will* not be heard to advance it here.”).
We therefore decline to reach this question, at least at this time.
We are, however, remanding this case to the district court for other purposes. With what is perhaps a superabundance of caution,