Klein and Board of Trade of the City of New York and futures trading

[*On Dec. 28, 2007 the Supreme Court dismissed the writ of certiorari in this case, according to its Rule 46.1. That rule states: "At any stage of the proceedings, whenever all parties file with the Clerk an agreement in writing that a case be dismissed, specifying the terms for payment of costs, and pay to the Clerk any fees then due, the Clerk, without further reference to the Court, will enter an order of dismissal." So, actually, the Clerk entered the order of dismissal...]

Big, big bucks are potentially at stakes in this case. It has to do with what is known as the "commodity futures" markets and the entity, the Board of Trade of the City of New York, which operates the market. Specifically, the Court is being asked the question of whether a "futures commission merchant" ("FCM"; Klein in this case), which buys and sells futures on the market, has standing in a lawsuit to sue the Board of Trade if it ignores its rules, and neglects its duties, which may (as in this case) lead to the collapse of not just Klein but of other companies, too.

I guess we need some more basic information. Klein sells futures for various commodities. Let's take orange juice. It is a commodity. If you buy stock in an orange juice company, you purchase it for whatever price is being asked on the market, and you keep it until you desire to sell. But in a futures contract you agree on a price either today or before the actual "delivery" of an orange juice contract in the future. By agreeing today, you "lock in" a price, which means that you can't lose any money if orange juice tanks between now and the delivery date of the contract; nor can you gain money if orange juice prices rise. In short, a futures contract "shifts the inherent market risks of price increases and decreases onto others who are willing to assume that market risk for profit opportunity," Petitioner's Brief for Writ of Certiorari, * 4.

Well you just don't show up at the futures market, plunk down your Franklins and buy futures. You have to work through a broker--an FCM. So, you buy through them. They buy futures on a commodity exchange operated by a board of trade, such as the defendant in this case. A clearinghouse, such as the NY Clearing Corp., works with the board of trade to clear (make happen) the trades on the exchange. So, we have markets, participants, commodities. What more do we need for the party to be complete? Oh, yes, we need oversight. We need to make sure that there are people in place who have eyes like hawks and talons like eagles (or is it the opposite?), who can make sure that no one comes in and starts messing with the markets.

Congress has spoken to this through law, our secular Scripture. Congress subjects boards of trade and participants to extensive oversight through the Commodity Exchange Act ("CEA"; 7 USC sec. 1 et seq.); it also has set up the Commodity Futures Trading Commission ("CFTC") as the primary regulator of boards of trade under the CEA.

Commodity Purchases and the Problem of This Case

A futures transaction is thus an ongoing relationship between the investor, his FCM, the board of trade and its clearinghouse. An investor who holds an account with a merchant (FCM) must make a minimum "margin payment" on its contracts, and the level of margin is established by rules of the board of trade in accordance with the CEA and CFTC regulations. The margin amount is a low percentage of the actual value of the contracts. Finally, a settlement price, a price adjusted for the contracts on a daily basis, is used to determine whether additional margin payments with respect to open contracts (those still being negotiated) are needed. Calculation of these settlement prices is the thing that got this case off the ground. For it was one of Klein's customers (an investor named Eisler), who was chairman of a committee which reported settlement prices, which consistently reported settlement prices so low that it didn't have to come up with additional margin money. The Board of Trade didn't catch this manipulation until it was too late. Then, Eisler's manipulation of the settlement price for technology futures had made him liable to huge margin calls. He couldn't pay it and so his broker, Klein, became liable for its client's deficiency. Klein couldn't pay the $4.5 million that it had to pony up immediately. So, it went under, too.

The Cases Below--What is At Issue

Eisler eventually got what was coming to him--a lawsuit, not brought by Klein, where he ended up having to pay nearly $5 million, without admitting liability of course, for the problems he "allegedly" caused. But Klein was still a closed business. So, it decided to sue the NY Board of Trade and the NY Clearinghouse under the CEA, alleging that its negligence had led to big problems. Only problem is that the courts below denied that Klein had standing under the CEA to sue. The relevant law 7 USC sec. 25. Here is where the issue gets complex. Klein wants to sue under sec. 25(b)(1) of the Act, which it claims allows a right of action on any person "who engaged in any transaction on" or "subject to the rules of" the board of trade or clearinghouse, but only "to the extent" of that person's "actual losses that resulted form such transaction or were caused by such failure to enforce or enforcement of such bylaws..." 7 USC sec. 25(b)(1).

But the court below, 464 F3d 255 (2nd Cir. (2006)), held that the standing requirements for (b)(1) were the same for those in sec (a)--which only relates to investors who are burned. Thus, the Second Circuit denied standing for Klein in this case. Case thrown out of court. The sole issue before the Supreme Court, then, is whether sec. 25(b)(1) of the CEA affords a broader grant of standing than sec. (a)(1) and, if so, then Klein would be eligible to bring its suit.

Conclusion

The reason that tons of dough is at stake here is that if the Supreme Court agrees with the Second Circuit, then FCM's like Klein will feel they have no protection against manipulative acts of their clients if the Board of Trade doesn't heed their cries for help. This will enganger the stability of the futures markets, it claims. Whether or not that is the reality I cannot say. I can say, however, that Klein has made a strong case for standing and for the requirements of sec. 25(b)(1) being different, and more inclusive, than those of 25(a)(1). But, unless you really are going to make this case your life, you probably will not be able to predict the outcome.

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