All That Glitters Isn’t Gold—Eleventh Circuit Affirms Injunction and Restitution Award Against Unregistered Traders in Metals Futures

In U.S. Commodity Futures Trading Commission v. Southern Trust Metals, Inc., 2018 WL 493116 (11th Cir. Jan. 22, 2018), the Eleventh Circuit affirmed an injunction and (most of) a restitution award against two companies and their principal for unregistered trading in metals futures.

Southern Trust told its customers that it would invest their money in precious metals, and could also lend them money for the investments. But Southern Trust did not actually trade in metals. Instead, Southern Trust’s CEO, Robert Escobio, opened accounts in two foreign futures brokerages under the name of Southern Trust’s parent company, Loreley Overseas Corporation, and invested Southern Trust’s customers’ money in metals futures—something Southern Trust couldn’t do directly, because it was not registered with the U.S. Commodity Futures Trading Commission (“CFTC”), as a trader in futures is required to be. Neither of the foreign brokerages was making loans to Loreley or charging any interest, but Southern Trust nevertheless charged “interest” to its own customers.

After receiving a customer complaint, the National Futures Association, a private self-regulatory agency, opened an investigation of Southern Trust. The NFA action ended in a settlement, but the CFTC also filed an action against Southern Trust, Escobio, and Loreley, alleging that the defendants failed to register as futures commission merchants, transacted in futures outside of a registered exchange, and promised their customers investments in metals but invested their money in futures instead. After a bench trial, the district court entered judgment in the CFTC’s favor on all claims, enjoined the defendants from trading in commodities, and awarded restitution to investors.

The Eleventh Circuit affirmed, except for one piece of the restitution award, which it remanded for consideration of other potential equitable remedies. The opinion, written by Judge Gilman visiting from the Sixth Circuit and joined by Judges Jordan and Hull, began by rejecting the defendants’ argument that the CFTC’s claims were barred, as a matter of equitable estoppel, by the defendants’ settlement with the NFA. The court noted that it is debatable whether equitable estoppel can ever be applied against the government, at least absent “affirmative misconduct” by the government, and joined the other circuits to have addressed the issue to hold that a settlement with a nongovernmental regulatory agency does not preclude subsequent claims by a governmental regulator.

The court also affirmed the district court’s conclusion that the defendants had violated 7 U.S.C. §§ 6b(a) and 9, and 17 C.F.R. § 180.1, which together prohibit fraud or deception in connection with the sale of futures contracts and include the same three elements: (1) a misrepresentation, misleading statement, or deceptive omission; (2) scienter; and (3) materiality. As to the first element, the court contrasted references in customer-facing documents to “physical metals” with the reality of Loreley’s investments, never disclosed to customers, in futures. As for scienter, the court recited the relevant standard—“highly unreasonable omissions or misrepresentations . . . that present a danger of misleading [customers] which is either known to the Defendant or so obvious that Defendant must have been aware of it”—and found that Escobio’s involvement in the scheme, paired with his industry experience, met the standard. As to the third element, materiality, the court agreed with the district court that a reasonable investor would consider the differences between metals and futures, not to mention those between a loan and the absence of one, material.

The court also affirmed the injunction prohibiting any of the defendants from working in the commodities-trading industry. Reciting the factors set forth in SEC v. Carriba Air, Inc., 681 F.2d 1318 (11th Cir. 1982), to guide the determination “whether the defendant’s past conduct indicates that there is a reasonable likelihood of further violations in the future,” the court rejected Escobio’s argument that his cooperation with the NFA required that the injunction be vacated. (That cooperation may have been offered, the court noted, “as a self-interested effort to strike a favorable deal[.]”)

But the court vacated the restitution award in favor of a group of Southern Trust investors who intended to invest in futures (rather than metals) but were misled into believing that Southern Trust was properly registered to effect those investments. The district court had employed a “reasonably foreseeable result” standard in determining that the defendants’ not being registered proximately caused those investors’ losses, citing the Eleventh Circuit’s decision in City of Miami v. Bank of America Corp., 800 F.3d 1262, 1282 (11th Cir. 2015). But that decision, the Eleventh Circuit noted, was later reversed, Bank of America Corp. v. City of Miami, 137 S. Ct. 1296 (2017). The proper standard “surely demands more than foreseeability alone.” Applying “the common-law rules . . . [which] include the notion that proximate cause encompasses cause in fact, requiring proof of ‘but-for’ causation,” the Eleventh Circuit found reversible error in the conclusion that the defendants’ lack of registration caused the losses suffered by investors who intended to trade in futures. But the court affirmed the separate restitution award to those investors who thought they were investing in metals rather than futures, and remanded the case for consideration of other potential equitable remedies, including disgorgement, for the investors who were led to believe that they were investing in futures with a registered broker.

Posted by Valerie Sanders.

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