U.S. Commodity Futures Trading Comm'n v. Monex Credit Co.

931 F.3d 966

U.S. COMMODITY FUTURES TRADING COMMISSION, Plaintiff-Appellant,

v.MONEX CREDIT COMPANY; Monex Deposit Company; Newport Services Corporation ; Michael Carabini; Louis Carabini, Defendants-Appellees.

No. 18-55815

United States Court of Appeals, Ninth Circuit.

Argued and Submitted March 13, 2019 San Francisco, California

Filed July 25, 2019

Robert A. Schwartz (argued), Deputy General Counsel; Anne W. Stukes, Assistant General Counsel; Daniel J. Davis, General Counsel; U.S. Commodity Futures Trading Commission, Washington, D.C.; for Plaintiff-Appellant.

Neil A. Goteiner (argued), Elizabeth A. Dorsi, and C. Brandon Wisoff, Farella Braun & Martel LLP, San Francisco, California, for Defendants-Appellees.

Before: Eugene E. Siler,^* A. Wallace Tashima, and M. Margaret McKeown, Circuit Judges.

SILER, Circuit Judge:

A two-letter conjunction and a two-word phrase decide this case. At stake are hundreds of millions of dollars. Congress, acting shortly after the economy began to stabilize from the financial crisis that began a decade earlier, passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010), which amended the Commodity Exchange Act (CEA) to expand the Commodity Future Trading Commission’s (CFTC) enforcement authority. This case is about the extent of those powers.

Monex Credit Company, one of the defendants and appellees, argues that the CFTC went too far when it filed this $290 million lawsuit for alleged fraud in precious metals sales. According to Monex, Dodd-Frank extended the CFTC’s power only to fraud-based manipulation claims, so stand-alone fraud claims—without allegations of manipulation—fail as a matter of law.

Not only that, Monex argues, but Dodd-Frank also immunizes Monex from the CFTC’s claims that it ran an unregistered, off-exchange trading platform. The CEA’s registration provisions do not apply to retail commodities dealers who "actual[ly] deliver[ ]" the commodities to customers within twenty-eight days. See 7 U.S.C. § 2(c)(2)(D)(ii)(III)(aa). Monex insists that it falls within this exception.

On both fronts, the district court agreed with Monex and dismissed the CFTC’s complaint for failure to state a claim under Civil Rule 12(b)(6). We REVERSE and REMAND .

Background

The facts come from the CFTC’s complaint, which, at this stage, we must accept as true. See Syed v. M-I, LLC , 853 F.3d 492, 499 (9th Cir. 2017).

Monex and the Atlas Program

California-based Monex has been a major player in the precious metal markets for decades. It sells gold, silver, platinum, and palladium to investors who have a variety of buying options, but here we focus on what Monex calls its "Atlas Program." Through Atlas, investors can purchase commodities on "margin." Also known as "leverage," the concept is simple: A customer buys precious metals by paying only a portion of the full price. The remaining amount is financed through Monex.

Once a customer opens an account, she may take open positions in precious metals. But the trading occurs "off exchange"—that is, it does not happen on a regulated exchange or board of trade. Instead, Monex controls the platform, acts as the counterparty to every transaction, and sets the price for every trade.

Since mid-2011, Monex has made more than 140,000 trades for more than 12,000 Atlas accounts, each of which requires margin of 22–25% of the account’s total value. A customer who deposits $25,000 in Atlas as margin can open positions valued at $100,000; she owes the additional $75,000 to Monex. Over time, the account’s value changes—it goes up and down—as markets do. The difference between the account’s total value and the amount the customer still owes to Monex is the account’s "equity." And if that difference falls below a certain threshold, Monex can issue a "margin call"—it can require customers to immediately deposit more money into the accounts to increase the equity. Monex can do so at any time, and it can change margin requirements whenever it wants.

Monex also retains sole discretion to liquidate trading positions without notice to the customer if equity drops too low, and it controls the price for every trade. Price spreads—the difference between the bid price and ask price—are 3% and generate much of the program’s revenue. Commissions and fees make up the rest, and that money comes directly out of customer accounts’ equity. Over the last eight years, Monex has made margin calls in more than 3,000 Atlas accounts and has force-liquidated at least 1,850.

Atlas investors can make either "short" or "long" trades. Short trades bet on metal prices going down, and long up. Monex allows investors to place "stop" or "limit" orders to manage their trading positions. About a quarter of trading positions in leveraged Atlas accounts open and close within two weeks.

Customers must sign the Atlas account agreement, which gives Monex control over the metals. Monex does not hand over any metals, and customers never possess or control any physical commodity. Instead, Monex stores the metals in depositories with which Monex has contractual relationships. Monex retains exclusive authority to direct the depository on how to handle the metals; investors and the depositories have no contractual relationship with each other. Customers can get their hands on the metals only by making full payment, requesting specific delivery of metals, and having the metals shipped to themselves, a pick-up location, or an agent.

This structure applies to both long and short positions. For a long position, Monex retains the right to close out the position at any time in its sole discretion and at a price Monex chooses. Metal remains in the depository, but Monex claims to transfer ownership of the metals to the customer. The same is true for short positions, except that instead of transferring ownership, Monex loans the customer metals that the customer immediately sells back to Monex. According to the CFTC, Monex simply makes a "book entry" when customers make trades—nothing more.

The Commodity Exchange Act and Dodd-Frank

The CFTC regulates commodity futures markets under the CEA. See 7 U.S.C. §§ 1 et seq . Part of the CEA’s purpose is "to protect all market participants from fraudulent or other abusive sales practices and misuses of customer assets." Id. § 5(b). The CEA requires that futures be traded on regulated exchanges. Id . § 6(a)(1). Brokers must register with the CFTC. Id . § 6d(a)(1). The CEA further protects against conflicts of interest and market abuse. Id . §§ 6d(c), 7(d). And the statute prohibits fraud. Id . § 6b(a)(2).

Originally, the CEA did not apply to retail commodity transactions because they were not futures contracts. See CFTC v. Zelener , 373 F.3d 861 (7th Cir. 2004). As Zelener recognized, the CEA applied only to futures contracts, even though other types of sales—such as leveraged retail commodity sales—can have similar economic effects. Id . at 866–67.

This changed in 2010 when Congress, acting in the wake of financial turmoil, passed Dodd-Frank—part of which amended the CEA. See Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Pub. L. No. 111-203, 124 Stat. 1376 (2010). Congress extended the CEA to commodity transactions offered "on a leveraged or margined basis, or financed by the offeror" "as if" they were futures trades. See 7 U.S.C. § 2(c)(2)(D)(iii). But Congress carved out an exception: The CEA would not apply to leveraged retail commodity sales that resulted "in actual delivery within 28 days." Id . § 2(c)(2)(D)(ii)(III)(aa).

Congress also amended the CEA by prohibiting the use of "any manipulative or deceptive device or contrivance" in market transactions. CEA § 6(c)(1). This language mirrored § 10(b) of the Securities and Exchange Act, and, as did § 10(b), authorized the governing agency to promulgate rules implementing the statute and bring civil enforcement actions. See 7 U.S.C. §§ 9(1), 13a-1(a) ; 15 U.S.C. § 78j(b).

Monex’s Alleged Scheme and This Lawsuit

The CFTC contends that Atlas is a scheme that has violated the CEA since at least July 2011. Monex tells its customers that leveraged precious metals trading is "a safe, secure and profitable way for retail customers to invest" when, in fact, the program requires that many customers lose money. What’s more, the CFTC alleges, Atlas is designed so that when customers lose, Monex gains: Because Monex is the counterparty for each Atlas transaction, Monex benefits from large price spreads at the customer’s expense. Sales representatives, too, have an incentive to push the program: Monex pays salespeople with "commissions and bonuses tied directly to the number of Atlas accounts they open" and the number of transactions completed; account performance is not a factor in compensation. So Monex engages in "high-pressure sales tactics," cajoling potential customers into buying leveraged precious metals while it "misrepresent[s] the likelihood of profit" and "systematically downplay[s] the risks" to ensure customers invest in Atlas, inevitably leading to customer losses.

The complaint alleges deep and broad losses to about 90% of all leveraged Atlas accounts—totaling some $290 million. In some cases, individual losses were extreme: some customers lost hundreds of thousands of dollars, and many others suffered five-figure losses. New investors never learned about those losses because Monex never told them. Instead, Monex promised that precious metals are safe and "will always have value," so a customer cannot lose her investment.

The CFTC filed this lawsuit seeking an injunction and restitution against Monex Deposit Company, Monex Credit Company, Newport Services Corporation, Louis Carabini, and Michael Carabini (Monex). The CFTC contends that Atlas is an illegal and unregistered leveraged retail commodity transaction market. The CFTC filed four counts, alleging violations of:

(1) CEA § 4(a), 7 U.S.C. § 6(a), for engaging in off-exchange transactions;

(2) CEA § 4b(a)(2)(

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