COMMODITY FUTURES TRADING COMMISSION, Plaintiff,

v.

AVCO FINANCIAL CORP., Anthony Vartuli and J. Michael
    Gent, Defendants.

No. 97 Civ. 3119(JFK).

United States District Court, S.D. New York.

Sept. 29, 1997.

Commodity Futures Trading Commission, New York, City, of
    Counsel, Ernesto Marrero, Jr., Karl D. Cooper, for the plaintiff.

Parson & Brown, New York, City, of Counsel, Paul M.
    Brown, for the defendants.

OPINION and ORDER

KEENAN, J.

Before the Court is the Defendants' motion to dismiss this action,
    pursuant to Fed.R.Civ.Pro. 12(b)(6), for failure to state a claim upon
    which relief may be granted. For the reasons stated below, the Court denies
    the motion.

Background

A. The Underlying Action

This civil enforcement action brought by the Commodity Futures Trading
    Commission (the "CFTC") is based upon Defendant AVCO Financial
    Corporation's ("AVCO") manufacture, advertisement and sale of a computer
    software program called "Recurrence" that generates specific
    recommendations to advise a customer to buy, sell or exit positions in
    exchange-traded futures contracts on Swiss francs and Japanese Yen.
    Defendant AVCO, Defendant Gent, the chief executive officer of AVCO, and
    Defendant Vartuli, the president and sole shareholder of AVCO, are not
    registered with the CFTC as commodity trading advisors.

The Complaint alleges the following facts, which the Court assumes as
    true for purposes of this motion: AVCO customers pay AVCO's licensing fee
    for the Recurrence software program, install the program on their personal
    computers, procure a marketing service to feed current market prices to
    their computer, and then act on the instructions given by Recurrence based
    upon the software's analysis of the current market prices. Recurrence gives
    the customers a specific buy or sell recommendation, as well as a specific
    stop and profit objective. The customers then call in their orders,
    pursuant to Recurrence's recommendations, to their brokers.

Recurrence is advertised as monitoring the market and the customer's
    position as the trading day progresses. Then, when additional instructions
    are warranted, the Defendants' system again creates an on-screen message
    and audio alert for the customer to follow immediately, exactly as
    instructed by the program. AVCO circulated an advertisement in the form of
    a "Dear Fellow Trader" letter that provided the following explanation of
    the Recurrence system:

When a historically profitable pattern develops, the system uses several
    parameters to evaluate the pattern in terms of the probability of profit or
    loss. If the percentages are greatly in your favor, Recurrence instantly
    signals a trade with both a screen message and audio alert. The 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 read the instructions right off your screen) and then sit back and
    watch as Recurrence monitors that market and your position in real time.
    When your profit objective is reached--or your stopped out--Recurrence
    alerts you again with an on-screen message and audio alert ... you must be
    willing to let the system 'call the shots,' and overcome your natural
    tendency to second-guess it.

Compl. para 30. Many of AVCO's customers and the brokers who traded for
    customers on the basis of Recurrence's recommendations "telephoned AVCO to
    ensure that AVCO agreed with the recommendations the customers and brokers
    were getting from the system.

Several placed orders only after ... AVCO employees confirmed
    [Recurrence's] recommendations." Compl. para. 31. AVCO has advertised the
    Recurrence program in such publications as Futures, CompuServe Magazine,
    Technical Analysis of Stocks and Commodities Magazine, The New York Times,
    The Washington Post, as well as through direct mail and phone
    solicitations, and promoted the program in its partnership packet and
    through promotional materials. These publications contain such statements
    as: The system is "automatic" and "all you have to do is decide whether or
    not to take advantage of the trade," Compl. para. 29(b); "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 their [sic] broker and place the appropriate trades,"
    Compl. para. 29(d); "Those traders with the vision, foresight and lack of
    ego necessary to let Recurrence IV tell them when to trade will begin
    taking profits immediately," Compl. para. 29(d); "Recurrence III makes
    money automatically", Compl. para. 33(a); Recurrence IV "Turns $2,500 into
    $121,000 in 5 years!", Compl. para. 33(b); "Between Jan. 1 1989 and
    December 31, 1994, trading only Swiss Franc futures, the system turned a
    $10,000 trading account into a $522,800 fortune --a return of 855% per
    years!", Compl. para. 33(d); "Our basic portfolio had average earnings of
    over $81,000 per year for six consecutive years", Compl. para. 33(e);
    "Guarantee: If the Recurrence Program does not produce a Total Net profit
    after 1 full year from the date of purchase, [AVCO] will refund 100% of
    your purchase price", Compl. para 40(c). In direct response to questions
    from customers as whether Recurrence's performance numbers were based on
    real trading, AVCO employees told customers that Recurrence's performance
    record was based on real trades, despite the fact that the promoted
    performance record was based on a hypothetical trading history. In
    addition, AVCO circulated an advertisement that stated:

Also for new traders, and for those who can't watch the markets during
    trading hours, we have developed a working relationship with a few special
    brokers using Recurrence and authorized by AVCO Financial corporation ...
    [T] hese authorized brokers can even actually trade the system's order for
    you if you own a copy of Recurrence. So if you can't monitor the system
    yourself, you can still take advantage of the time-proven profitability of
    Recurrence.

Compl. para. 30.

The CFTC asserts that, through the Recurrence program, AVCO acts as a
    commodity trading advisor by providing investment advice for trading
    commodity futures. Insofar as AVCO is not registered as a commodity trading
    advisor, the CFTC argues that AVCO violates the CEA. The CFTC further
    claims that AVCO's promotional statements to actual and prospective
    customers contain misrepresentations as to the profitability of the advice
    given by Recurrence, the accuracy of Recurrence, the performance history of
    Recurrence, and the risks involved in trading commodity futures with
    Recurrence. Based on the activities alleged above, the Complaint states
    three counts against the Defendants: (1) solicitation fraud in violation of
    the CEA; (2) fraud by a commodity trading advisor and fraudulent
    advertising in violation of the CEA; and (3) acting as a commodity trading
    advisor without registering in violation of the CEA. The CFTC has moved for
    preliminary injunctive relief in this case, and the parties consented to
    the entry of an order preventing the Defendants from engaging in the
    activities at issue in this action pending a decision on the preliminary
    injunction motion. The CFTC also seeks disgorgement, an order assessing
    civil penalties against the Defendants, and an order of restitution
    directing the Defendants to make whole each and every client for all losses
    sustained due to the Defendants' illegal actions.

Defendants move to dismiss all three counts in the Complaint on the
    grounds that the CFTC has not alleged facts demonstrating that AVCO is a
    commodity trading advisor under the CEA, and therefore Defendants argue
    that AVCO is not amenable to the CFTC's regulatory jurisdiction. Defendants
    also assert that the count one claim must be dismissed because the
    Complaint has failed to satisfy the requirement that the alleged fraud be
    "in connection with" an order to make or the making of a "contract for sale
    of any commodity for future delivery."

B. AVCO's Bankrupcty

On August 25, 1997, after this motion was fully briefed, Defendant AVCO
    filed a voluntary petition for bankrupcty. As a general rule, such a filing
    by a defendant automatically stays any action against the defendant. See 11
    U.S.C. sec. 362(a). However, sec. 362(b)(4) of the Bankruptcy Code
    expressly exempts actions or proceedings brought "by a governmental unit to
    enforce such governmental unit's police or regulatory power" from the
    automatic stay afforded bankrupcty debtors. Id. sec. 362(b)(4). Insofar as
    the CFTC is a "governmental unit," this action was brought to enforce the
    CFTC's police power and effectuate the public policy of the CEA rather than
    adjudicate private rights or pursue restitution for the government, and the
    relief sought by the CFTC is designed to end the CEA violations, make the
    alleged fraud unprofitable, deter future violations of the CEA and serve
    the policies underlying the CEA, the Court concludes that this action is
    not stayed as against AVCO and the CFTC may proceed with the prosecution of
    this civil enforcement action. See CFTC v. Incomco, Inc., 649 F.2d 128, 133
    (2d Cir.1981) ("The commencement or continuation of actions brought by
    governmental agencies to enforce regulatory or police powers is
    specifically exempted from the automatic stay provisions of the [Bankrupcty
    Code]."); SEC v. Towers Fin. Corp., 205 B.R. 27 (Bankr.S.D.N.Y.1997)
    (holding that SEC enforcement action seeking injunctive relief and
    disgorgement was exempted from automatic stay because the action served to
    effectuate public policy); Ngan Gung Restaurant, Inc. v. People of the
    State of New York, 183 B.R. 689, 694 (Bankr.S.D.N.Y.1995) (holding that
    enforcement action was exempted from the automatic stay because "the
    request to enjoin the defendants from further violations of the [New York
    State Labor Law] and the request for unpaid wages and liquidated damages
    are simply a method of enforcing the policies underlying [that law] ").

Discussion

A motion to dismiss for failure to state a claim should be granted only
    if it appears beyond doubt that a plaintiff can prove no set of facts in
    support of a claim that would entitle the plaintiff to relief. See Conley
    v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957). The
    factual allegations set forth in the complaint must be accepted as true,
    see Zinermon v. Burch, 494 U.S. 113, 118, 110 S.Ct. 975, 979, 108 L.Ed.2d
    100 (1990), and the court must view those allegations in the light most
    favorable to the pleader. See Scheuer v. Rhodes, 416 U.S. 232, 236, 94
    S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974). The burden on the moving party is
    heavy because "the sanction of dismissal is harsh," Duncan v. AT & T
    Communications, Inc., 668 F.Supp. 232, 234 (S.D.N.Y.1987), and because "the
    purpose of pleading is to facilitate a proper decision on the merits."
    Conley, 355 U.S. at 48.

A. Whether the Complaint adequately alleges that AVCO was a commodity
    trading advisor under the CEA

Under 7 U.S.C. sec. 1a(5)(A), a person is a commodity trading advisor if
    that person: (1) advises others about the value of or the advisability of
    trading in commodity futures contracts, (2) "either directly or through
    publications, writings or electronic media," (3) for compensation or
    profit, (4) unless that person is "the publisher or producer of any print
    or electronic data of general or regular dissemination," if such
    publisher's or producer's provision of commodity futures trading advice is
    "solely incidental to the conduct of [its] business or profession." 7
    U.S.C. sec. 1a(5)(A)-(C). The Complaint alleges that AVCO advises
    customers, through the Recurrence software program, as to the advisability
    of trading futures contracts on Swiss francs and Japanese yen. See Compl.
    paras. 23-24, 42. Customers allegedly paid AVCO from $2500 to $4500 for the
    right to obtain the advice from the Recurrence system. See Compl. para. 42.
    The Recurrence system is alleged to provide messages on the customer's
    computer screen that give the customer a specific buy or sell
    recommendation, as well as a specific stop and profit objective, based upon
    the systems analysis of the current market prices. See Compl. para. 24. The
    system allegedly monitors the market and the customer's position as the
    trading day progresses, and when additional instructions are warranted, the
    system again creates an on-screen message and audio alert for the customer
    to follow, exactly as instructed by the program. See Compl. para. 24.
    Customers then call in their orders as instructed by the system's on-screen
    message. The CFTC asserts that many AVCO customers telephoned AVCO
    employees to ensure that AVCO agreed with Recurrence's recommendations, and
    some customers placed orders only after confirmation of the
    recommendations. See Compl. para. 31. Additionally, AVCO allegedly provided
    a service to customers under which brokers authorized by AVCO could trade
    on a customer's behalf according to Recurrence's instructions if the
    customer could not monitor the system throughout trading hours. See Compl.
    para. 30. The CFTC also alleges that AVCO promoted itself to actual and
    potential customers as providing highly profitable commodity futures
    trading advice through the Recurrence program. See Compl. paras. 29-30.
    Taking all of these allegations as true, and viewing them in the light most
    favorable to the CFTC, the Court concludes that the Complaint adequately
    alleges that AVCO is a commodity trading advisor under the plain language
    of the CEA.

Defendants rely on Lowe v. SEC, 472 U.S. 211 (1985), and assert that
    AVCO is not a commodity trading advisor because AVCO does not provide
    personalized investment advice. In Lowe, the Supreme Court interpreted a
    statutory exclusion to the definition of an "investment advisor" under the
    Investment Advisers Act ("IAA"), which excepted from the registration
    provisions of the IAA "the publisher of any bona fide newspaper, news
    magazine or business or financial publication of general and regular
    circulation ." Id. at 204. The Supreme Court held,

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.

Id. at 210. This Court observes, however, that the statutory exclusion
    to the definition of a commodity trading adviser under the CEA is narrower
    than the IAA exclusion addressed in Lowe. The CEA commodity trading advisor
    definition excludes "the publisher or producer of any print or electronic
    data of general and regular dissemination ... only if the furnishing of
    such [investment advise] services is solely incidental to the conduct of
    their business or profession." 7 U.S.C. sec. 1a(5)(B)-(C) (emphasis
    added).

From the allegations in the Complaint, the Court can draw the inference
    that AVCO's business was to provide commodity trading advice through the
    Recurrence program. Thus, the statutory exclusion to a commodity trading
    advisor does not apply. Furthermore, even if the Court were to apply the
    Lowe holding to the statutory exclusion in this case, the Court concludes
    that the Complaint alleges facts indicating that AVCO provides personalized
    investment advice to customers. According to the Complaint, unlike a
    generally disseminated newsletter which provides nonpersonal investment
    advice, AVCO's investment advice is communicated on an irregular basis in
    response to certain market conditions, the Recurrence program gives the
    customer specific buy and sell and stop and profit objective
    recommendations, the program monitors the customer's position throughout
    the trading day and provides specific additional instructions as the market
    changes for the customer to immediately follow, customers telephone AVCO
    employees for advice as to the Recurrence recommendations, and AVCO
    provides customers a service by which brokers authorized by AVCO can
    actually make trades pursuant to the system's orders for customers who
    cannot monitor the system during trading hours. See Compl. paras. 23-24,
    29-31. These allegations negate the Defendants' assertions that AVCO's
    investment advice is entirely impersonal and not characteristic of
    investment adviser-client relationships meant to be covered by the CEA. In
    light of this conclusion, the Court need not address the Defendants'
    arguments that the first amendment protects against government regulation
    of nonpersonalized investment advice, which the Defendants' claim is the
    type of advice provided by Recurrence.

2. Whether the Complaint adequately allege that the alleged ?? "in
    connection with" the ?? commodity

Count three of the Complaint alleges that the Defendants are in
    violation of 7 U.S.C. sec. 6b(a)(i), which prohibits any person from
    cheating or defrauding another person "in connection with any order to
    make, or the making of, any contract for sale of any commodity for future
    delivery...." The CFTC alleges that from at least 1993 to the present ...
    the Defendants ... cheated or defrauded or attempted to cheat or defraud
    other persons by making false, deceptive or misleading representations or
    omissions of material fact during the course of soliciting customers to
    purchase computerized commodity futures trading systems intended to be
    used, and which were used by customers, in connection with the purchase or
    sale of commodity futures contracts.... Compl. para. 47. The alleged
    misrepresentations at issue include AVCO's advertisements that the
    Recurrence program generated large profits, had an extremely high degree of
    accuracy in picking winning trades, and involved little or risk of loss
    based upon Recurrence's past results obtained in actual trading. See Compl.
    paras. 33-45. The Complaint also alleges that AVCO failed to disclose that
    Recurrence's advertised performance record was based upon a hypothetical
    trading history, rather than actual trading.

Defendants contend that the allegations in support of the sec. 6b claim
    do not meet the "in connection with" requirement of sec. 6b because the
    factual allegations do not show "both a transaction (the order or making of
    the contract), and a link between the fraud and the transaction (that the
    fraud was in connection with the transaction)." Defs. Mem. at 22. The Court
    disagrees.

The Complaint's detailed allegations that AVCO failed to disclose and
    minimized the risks of commodity futures trading with the Recurrence
    system, see Compl. paras. 40-43, satisfy the "in connection with
    requirement" of sec. 6b. See Saxe v. E.F. Hutton & Co., Inc., 789 F.2d
    105, 109-12 (2d Cir.1986). The Complaint's detailed allegations that AVCO
    failed to disclose that Recurrence's advertised performance record did not
    represent the results of actual trading but hypothetical trading, see
    Compl. paras. 37-39, also satisfy the "in connection with requirement" of
    sec. 6b. See CFTC v. Skorupskas, 605 F.Supp. 923, 933 (E.D.Mich.1985) ("the
    failure to disclose information that a performance record does not
    represent the results of actual trading but of hypothetical or fictitious
    trading" held to violate sec. 6b). Insofar as the Defendants' alleged
    misrepresentations dealt with the profitability and risks associated with
    following Recurrence's recommendations in trading commodity futures
    contracts, and numerous contracts were allegedly traded pursuant to
    Recurrence's recommendations, the CFTC has alleged a sufficiently close
    nexus between the alleged fraud and the commodity futures trading to
    satisfy the "in connection with" requirement of sec. 6b. See Saxe, 789 F.2d
    at 109-12.

Conclusion

For the reasons stated above, the Court denies the Defendants' motion to
    dismiss. The parties are to appear before the Court for a conference in
    courtroom 20c on October 31, 1997 at 10:00 a.m.

SO ORDERED.