Commodity Futures Trading Commission v. Risk Capital Trading Group, Inc. (452 F. Supp. 2d 1229, 2006)

ORDER

EVANS, District Judge.

This civil enforcement action brought under the Commodity Exchange Act (the “Act”), 7 U.S.C. § 1 et seq., is currently before the Court for findings of fact and conclusions of law as to Plaintiffs claims against Defendant Rick Siegel (“Siegel”) following a bench trial on June 12-15, 2006.

Plaintiff Commodity Futures Trading Commission (“Plaintiff’ or “CFTC”) is the independent federal regulatory agency charged with the administration and enforcement of the Act and the regulations promulgated thereunder, 17 C.F.R. § 1.1 et seq. Plaintiff alleges that Siegel, in his capacity as an Associated Person (“AP”) of Risk Capital Trading Group, Inc. (“Risk Capital”), violated the anti-fraud provisions of the Act, specifically 7 U.S.C. § 6b(a)(2)(i) and (iii), 7 U.S.C. § 6c(b), and 17 C.F.R. § 33.10, in soliciting customers to buy and sell commodity futures contracts and options on commodity futures contracts. Plaintiff claims that Siegel caused his customers to invest money under a false impression of the probability of large profits. Almost all of Siegel’s customers lost all or substantial portions of their investments.

Plaintiff seeks a permanent injunction, restraining Siegel from further violating the Act and also from engaging in any commodity-related sales activity.

Plaintiff seeks restitution in the following amounts for the four former customers of Siegel who testified at trial: Etienne Brown — $2,985.12; Michael Maiorino— $ 9,432; Sandra Brothers — $8,301.92; and Dean Wiegand' — $2,892.41. Plaintiff also seeks restitution for all of Siegel’s other customers in the amount of $990,492.55.

Plaintiff seeks disgorgement of Siegel’s compensation derived from his customers in the amount of $102,417.

Finally, Plaintiff seeks civil monetary penalties in the maximum amount allowed under the Act of $120,000 for each violation of the Act.

Having heard the evidence and arguments presented by the parties and having reviewed their briefs which have been filed, the Court makes the following findings of fact and conclusions of law:

I. Findings of Fact

Beginning in January 2001, Risk Capital operated as an “introducing broker,” soliciting orders for options and futures contracts. Its primary place of business was in Atlanta, Georgia. Risk Capital sold predominantly commodity options to small retail customers whose business was sought through “cold call” telemarketing. Risk Capital closed in September 2003, following an investigation and Complaint by the National Futures Association (“NFA”), an investigation by the CFTC, and the filing of the instant lawsuit.

The trial evidence showed that Risk Capital was a scam: Its principals had been involved in other similar schemes. By using aggressive sales techniques and false and misleading representations with clients who were gullible and vulnerable, Risk Capital induced the clients to pay commissions (often on a repeat basis) for speculative investments which had no real chance of success.

From 2002 to 2003 Risk Capital took in approximately $7,300,000 in commissions in $200 and $100 increments. It had over 1,000 customers who collectively lost over $11,000,000. Approximately 97% of Risk Capital’s customers lost money — exceeding the 85% loss rate which has been estimated for the small investor commodity industry as a whole.

Risk Capital’s customers usually purchased “call” options. The owner of a call option on a futures contract has the right to purchase the underlying futures contract at a specified price (“strike price”) at any time before a specified date in the future. Risk Capital sold primarily so-called “deep out of the money” call options. These options are cheap in relation to other options because the strike price is so far above the futures market price (when the option is purchased) that it is highly unlikely that the futures market price will ever reach the strike price. In the highly unlikely event that the market rises above the strike price, the option holder can make a large leveraged profit. Otherwise a modest profit can be made by selling the option on the secondary options market if and when the market price for the option has risen above the price originally paid by the client. Of course, the client’s breakeven point includes not only the price of the option (called the “premium”) but also commissions and NFA fees.

The movement of the commodity options market is unpredictable and can be volatile. Capturing a profit (or minimizing a loss) through sale of the option requires close, continuous attention to the market and an element of luck in effecting the sale before the market worsens. Sale of an option at a loss may be the best course of action. The passage of time (moving toward the expiration date) tends to degrade the option’s value. When an out-of-the-money option expires, it is worthless and the customer will have lost his total investment (the price of the option plus commissions and NFA fees).

Occasionally Risk Capital’s clients would purchase commodity futures contracts. A commodity futures contract is a contract to buy (or sell) a standard quantity of a particular commodity at a specified price and time in the future. The owner of a futures contract is exposed to risk far beyond the purchase price of the futures contract. If he still owns the contract at maturity, he would be forced to purchase (or sell) the specific commodity at the price set in the contract or to meet his obligation through alternative means.

Risk Capital purchased names and telephone numbers of potential customers. Its representatives would make cold calls to these prospects, often using misleading sales scripts. The cold caller would fill out a prospect information sheet which would describe the call. If the prospect showed some interest, the cold caller would send Risk Capital’s “Risk Disclosure Packet” and the prospect information sheet would be turned over to an account executive (such as Siegel) who would make a followup sales call. If an account was opened, the account executive would make the first options purchase. The account would then be turned over to a “trading advisor” who determined when the option should be sold and who would pitch another investment. Risk Capital had four trading advisors. Because 97% of Risk Capital’s clients lost money, the Court infers that either the trading advisors did not adequately follow the movement of the options market or that the market rarely moved above the clients’ break-even point within the option period, or both.

While Risk Capital utilized written risk disclosures signed by clients, as well as recorded client interviews to document clients’ appreciation of the high risk in commodities trading, it also undertook to offset the cautionary effect of these warnings. One such measure was the aggressive, overly optimistic verbal sales pitch of the account executive seeking to open the account. Another was the routine coaching of prospective customers that the risk disclosure form and recorded interview had to be done a certain way — otherwise, they would not be allowed to open an account. Clients were told that they should state a certain level of income and level of assets (whether true or not) and that when asked if anyone had coached them on what to say in the recorded interview they should say “no.”

Prior to joining Risk Capital, Siegel was a “market maker” on the floor of the Chicago Board of Trade for twenty years. ’He owned a seat on the Board of Trade. Sie-gel mainly traded in the bond futures market but also traded in a wide variety of commodity futures. He traded for his own account and made significant profits in all years except the last one. Prior to the initiation of this lawsuit, Siegel never was the subject of an enforcement action.

After leaving the Chicago Board of Trade, Siegel took some time off before joining Risk Capital on February 19, 2002. He was employed in the Atlanta office as an AP. Siegel’s title was Account Executive. He rarely made cold calls. His primary function was to persuade customers to open accounts and to send in the initial deposit for trading. He was a persuasive salesman. Once the account was opened, Siegel would make the first options purchase for a new customer. When a customer was considering purchasing a commodity futures contract (as opposed to an option), Siegel would handle that transaction. He was Risk Capital’s only AP who was allowed to handle futures contracts.

Siegel shared an office with Mark Chambers, who was his assistant. Chambers did Siegel’s paperwork. This included checking to make sure that new clients had filled out the risk disclosure forms in the “right” way — that is, to meet minimum financial requirements and to verify an understanding of the risks of trading, and to verify that no one had coached them. When the forms were not filled out in the manner which permitted the account to be opened, Chambers would call and give instructions to the client. The Court infers that Siegel overheard these telephone calls.

Risk Capital’s account executives and trading advisors were commission-paid. Each options purchase involved a $200 commission. . Each futures contract purchase called for a $100 commission. The commission was split among Risk Capital (60%) and also among all persons who had advised the client, including the account executive who had opened the account and the trading advisor. Siegel was entitled to consideration for bonuses, and Risk Capital paid his apartment rent. Siegel’s income from Risk Capital was primarily tied to his success in getting clients to open accounts and send in their money.

Siegel spent his first three days at Risk Capital observing and listening to other APs converse with prospective and current clients. He was troubled by some of the leveraging examples he heard other APs providing to customers. He observed some of the APs using sales scripts. After that he began to open accounts. Siegel did not use sales scripts to solicit customers or to discuss trades with them. Siegel did tell potential customers that options and futures trading was risky, but he also emphasized his considerable past experience plus the fact that he personally had been successful financially in the commodities field. He encouraged his customers to trust in his judgment and rely on his expertise, downplaying the need to be concerned with the extensive warnings in the written materials they had received from Risk Capital.

While Siegel’s representation that he had considerable experience trading futures contracts and options was literally true, trading on the floor of the Chicago Board of Trade was far different from working in Risk Capital’s retail sales office. Most importantly, at Risk Capital he did not have access to up-to-the-minute new information as he had had on the floor of the Chicago Board of Trade. Also, neither Siegel nor the trading advisors could effect trades as quickly as at the Board of Trade. According to testimony at trial, which the Court credits, the commodity futures market very quickly factors new information into prices. Thereafter, the information has no relevance to later movement of the market. The Court is doubtful that Risk Capital’s APs had any special information or insights which were helpful in trading options on futures contracts.

In explaining commodity trading to prospective clients, Siegel used the “delta” concept to explain that the upward movement of futures contract prices can result in large leveraged increases in the value of an option to purchase the contract. It is correct that such increases can occur. However, because most of Risk Capital’s customers purchased deep out-of-the-money options (the cheapest options and the least likely to result in a large profit), the “delta” formula had little practical application; it served only to add a formulaic patina to what was really more like buying a lottery ticket.

After Siegel had made the first options purchase for a client, he would tell the client that the account had been turned over to one of four “trading advisors” who would advise the client as to when to sell the option. These sales normally caused losses, triggering complaints from clients who had been expecting profits based on Siegel’s projections. The clients would often contact Siegel again for an explanation or to seek advice.

The Court also infers and finds that after Siegel had worked at Risk Capital for a period of time, he gained an actual awareness that almost all of the customers were losing their investments, including those whose accounts he had opened. Certainly, that must have been true by the fall of 2002. Siegel knew because clients called him with complaints about the trading advisors. The trading advisors’ track records, which were disastrous, are set forth in Plaintiffs Exhibits 97 and 101. Nonetheless, he continued with prospective clients to emphasize his own expertise and the fact that he had had financial success with commodity trading despite its risky nature. This was deceptive because the trading advisors, who he knew would be making the decision as to when to sell the option, regularly sold at a loss.

At trial, Plaintiff called four previous customers of Risk Capital to testify about their dealings with Risk Capital and Sie-gel.

1. Etienne Brown

Etienne Brown (“Brown”) had limited investment experience in stocks and mutual funds. He had no experience in commodities markets and no understanding of how those markets worked.

Brown testified that he was cold called by Siegel in May or June 2002. According to the prospect information sheet memorializing this phone call, however, Jason McGill was the cold caller. The Court finds that Brown was mistaken about the identity of his cold caller. The prospect information sheet is dated May 14, 2002 and has McGill’s name on it. The Court accepts Siegel’s testimony that the handwriting on the sheet was not his. Def.’s Ex. 39 (RS-00173). McGill and Brown discussed the unleaded gasoline market but Brown did not agree to invest at this time. He requested additional information.

After Brown received a packet of materials Siegel called Brown. They developed a good rapport. Brown was impressed by Siegel’s experience in and knowledge of the commodities market.

Brown opened an account at Risk Capital, depositing a total of $5,450. Siegel was the account executive. Siegel said that there were opportunities in the soybean market. Brown could not recall the exact reasons Siegel gave for why the soybean market was attractive, but he said that the reasons had something to do with drought, harvest shortages, and pestilence in certain areas that would cause supply to be depressed. Brown purchased 5 soybean call options on or around May 13, 2002 for $5,450, of which the premium was $4,250, the commissions were $1,000, and the NFA fees were $200. The trade ticket for this investment is dated May 31, 2002 and bears the initials “RS/JMC,” meaning that Siegel earned the primary commission on the trade and McGill earned a residual commission for making the cold call.

After this first purchase, Brown’s account was transferred to Deron Baugh, a trading advisor at Risk Capital. Baugh recommended that Brown sell his soybean call options, which were showing a profit, and invest in 8 call options on Euro futures. Brown agreed to the proposed investment and the trade was placed on or around June 28, 2002. The premium for the 8 Euro options was $4,800, and Brown paid $1,600 in commissions and $320 in fees. Brown was notified that he owed an additional $470 to cover the cost of the trade, which he refused to pay. Brown did not like Baugh and the trade which Baugh recommended lost money. Ultimately, the 50% stop loss placed on the Euro investment was triggered and Brown’s account value was $1,690, reflecting a decline of $3,110 or 64.8%.

Brown submitted a complaint to the NFA on July 22, 2002 concerning his dealings with Baugh. Ultimately, Risk Capital agreed to refund the amount lost in Brown’s account on the condition that he continue to invest with Risk Capital. Brown agreed and signed a release form. He requested that his account be transferred back to Siegel because he was comfortable with him and they had a good rapport.

Siegel did not charge Brown commissions on further trades. He recommended that Brown purchase call options on wheat futures, citing reasons similar to the ones he gave for investing in soybeans. Per Siegel’s advice, Brown purchased three call options on wheat futures on or around September 10, 2002. Siegel placed a 50% stop-loss order on this trade. Brown testified that he was under the impression that this meant that he could lose no more than half of his investment. The Court finds that while Brown may have been under this impression during the trade with Baugh, by the time of his final trade with Siegel, he knew that the 50% stop-loss did not guarantee that losses would be limited to 50% of the investment. The details of this final investment are unclear, but apparently it fared poorly.

Brown closed his account and received a check for approximately $836. He did not file a complaint with the NFA against Siegel.

2. Michael Maiomo

Michael Maiorino testified that Siegel cold-called him and discussed trading options on commodity futures. Maiorino testified that Siegel stated that he was a successful AP; that the heating oil futures market was promising because the winter months were approaching and the demand for heating oil would increase; that small moves in the price of the heating oil futures market would yield large profits for investors; and that Maiorino could make 4 or 5 times his investment if he invested soon.

Siegel testified that he did not place the cold call to Maiorino and that he had not been the Account Executive. Mikeal Mas-terson cold called Maiorino and another Account Executive, Jack Sini (“Sini”), was the account executive. Siegel stated that Maiorino and Sini were arguing over whether Maiorino could buy an option with a different strike price than the one Sini was attempting to sell him. Sini asked Siegel to discuss this matter with Maiori-no. Siegel testified that he had a two-minute conversation with Maiorino, after which Sini placed the order that Maiorino desired.

The Court finds Siegel’s version of the story more credible because it is supported by objective evidence, and because it was clear that Maiorino’s memory of the events in question was lacking. First, the prospect information sheet confirms that Mas-terson did call Maiorino on December 3, 2002. Additionally, Maiorino’s trade tickets are not in Siegel’s handwriting. Sie-gel’s initials do not appear in the box in which the initials of Maiorino’s primary APs appear. Siegel’s initials do appear outside of the box because of Risk Capital’s policy that any AP who talked to a client (even if only for a short period of time) would receive a portion of the commissions generated on the account. The objective evidence shows that after the initial trade was placed the account was transferred to David Mittler, a trading advisor.

Thus, the Court finds that with respect to Maiorino, Siegel had only a brief conversation that did not involve any misrepresentations.

3. Dean Wiegand

Prior to investing with Risk Capital, Dean Wiegand, a farmer in Canada, had no investment experience. It was clear at trial that he had no understanding of the commodities market.

In March 2002, Wiegand was called by Desmond Muthemba, an AP at Risk Capital. Muthemba told Wiegand that peak driving season was approaching and that crude oil was a good investment. Mu-themba stated that other investors had doubled and tripled their money in that market and the faster Wiegand invested the better. Wiegand agreed to invest money with Muthemba. Muthemba faxed the account opening documents to Wie-gand. Wiegand did not read the documents; he just signed them, faxed them back to Muthemba, and wired approximately $3,000 on March 22, 2002. That same day, Muthemba placed an order to purchase three option contracts on unleaded gasoline futures.

Some time later, Wiegand received a phone call from Siegel, who told Wiegand that he had lost $2,000 and that only $1,000 remained. Siegel stated he was optimistic about making the money back with the remaining $1,000. He told Wie-gand that he would call back when an investment opportunity arose.

Approximately one week later, Siegel called Wiegand and told him that the gasoline futures market was an attractive investment. Wiegand testified that Siegel told him that there was an announcement coming out and that if the announcement was favorable, Wiegand could make money. Wiegand said that he “had to go with [Siegel’s] knowledge instead of his.” The trade was placed on April 17, 2002. Shortly thereafter, Siegel called Wiegand and informed him that the investment had been sold at a loss.

Wiegand closed his account and received a check from Risk Capital in the amount of $107.59.

4. Sandra Brothers

Sandra Brothers’ memory of the events in question was lacking, and the Court questions the credibility of some of her testimony. However, Plaintiff presented notes of conversations with Siegel that Brothers had made contemporaneously with the conversations, as well as other objective evidence that corroborated some parts of her testimony.

From 2002 to 2003, Brothers was a sales representative at a department store in Georgia. According to her testimony, she had between $100,000 to $150,000 invested in mutual funds for retirement. She read money and investment magazines on occasion. Her only experience with investing was with mutual funds.

On September 24, 2002, she received an unsolicited phone call from Muthemba at Risk Capital. Brothers’ testimony concerning the call contradicts the prospect information sheet that Muthemba completed during their conversation. According to the prospect information sheet (which the Court finds to be more credible), Brothers indicated some interest in investing in commodity futures and options. Muthemba wrote:

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