Opinion ID: 741862
Heading Depth: 2
Heading Rank: 1

Heading: The Authority of a Customer's Third-Party Designee

Text: 23 Section 4b(A) of the CEA makes it unlawful for SHB to make trades against a customer's account without the customer's permission. 7 U.S.C. § 6(b). Peltz concludes that he is not responsible for the margin call SHB charged to his account because SHB failed to get permission under 17 C.F.R. § 166.2 before SHB cleared Weingarten's trades. This failure, Peltz contends, shifts liability exclusively to SHB. SHB responds that Weingarten had sufficient authority to make the trades, and therefore, Peltz must pay the debit to his account. 24 Rule 166.2 was promulgated under the CEA, and states that 25 [n]o futures commission merchant, introducing broker or any of their associated persons may directly or indirectly effect a transaction in a commodity interest for the account of any customer unless before the transaction the customer, or person designated by the customer to control the account--(a) Specifically authorized the futures commission merchant, introducing broker or any of their associated persons to effect the transaction (a transaction is specifically authorized if the customer or person designated by the customer to control the account specifies (1) the precise commodity interest to be purchased or sold and (2) the exact amount of the commodity interest to be purchased or sold); or (b) Authorized in writing the futures commission merchant ... to effect transactions in commodity interests for the account without the customer's specific authorization. 26 17 C.F.R. § 166.2. In sum, an FCM may execute trades for a customer only after the customer or someone designated by the customer to control the account specifically authorize[s] the trades under § 166.2(a), or provides the FCM with written authorization for the trades under § 166.2(b). 27 It is clear from the rather straightforward language of the regulation that an FCM needs written authorization to make trades only when the FCM has not received specific[ ] authoriz[ation] for the transaction. See 17 C.F.R. § 166.2(b). Under the regulation, only two persons can give such specific[ ] authoriz[ation]--the customer himself, or the person designated by the customer to control the account. 17 C.F.R. § 166.2. Peltz adds a requirement, appearing nowhere in the Rule, that the designation of a person to control the account must be by a written power of attorney. From this Peltz reasons that because he did not execute such written power of attorney, and did not authorize the trades in writing under 166.2(b), SHB should not have made the trades. Peltz's interpretation of the regulation does not bear scrutiny. 28 Everyone agrees that Peltz did not give SHB a written authorization to make the trades, nor a written power of attorney allowing Weingarten to make trades on his behalf. While lack of written authorization for SHB to make the trades means that SHB could not execute the transactions under 166.2(b), the lack of a written power of attorney designating Weingarten to control the account does not rule out the possibility that SHB had specific[ ] authoriz[ation] from the customer's designee to accept the orders under § 166.2(a). Nothing in the regulation or in the caselaw interpreting subdivision (a) requires that, before an FCM makes trades specifically authorized by a designee, the FCM has to get written authorization from a customer appointing the designee. While written authorization may help an FCM to determine whether an individual is indeed a person designated by a customer to control the account, it is not a legal necessity. 29 Peltz argues that this lax interpretation runs contrary to that announced by the Commodity Futures Trading Commission 1 , the entity responsible for policing the COMEX and those who trade in futures, in Matter of Heitschmidt. See Matter of Heitschmidt, [1994-1996 Transfer Binder] Comm.Fut.L.Rep. (CCH) p 26,263 at 42,204 (CFTC Nov. 9, 1994). In Heitschmidt, the CFTC announced that 30 [a] liability analysis under Commission Rule 166.2 focuses on two issues: (1) whether there was a written power of attorney in effect at the time of the transaction at issue and, if not, (2) whether the transaction was specifically authorized by the customer in advance of its execution. See Wolken v. Refco, Inc., [1987-1990 Transfer Binder] Comm.Fut.L.Rep. (CCH) p 24,509 at 36,188 (CFTC July 18, 1989). Under Rule 166.2, a customer's oral grant of general discretion to an account executive is irrelevant to the analysis of liability because the rule renders such agreements void. 31 Id. Peltz concludes from this statement that a broker accepting trades from a person other than the customer without written authorization commits a prima facie violation of the [CEA]. Appellant's Brief at p. 29. Peltz misinterprets Heitschmidt. 32 Heitschmidt involved unauthorized trading by an associated person (AP) (a person associated with an FCM) of both discretionary and non-discretionary accounts. The CFTC found that the AP's trades against the discretionary account violated Rule 166.2 because, despite the customer's oral revocation of written authorization it had sent the AP to make the trades under 166.2(b), the AP made trades without consulting the customer. p 26,263 at 42,205. As to the nondiscretionary accounts, the Commission found that the AP had made trades beyond the customer's general instructions. 33 Heitschmidt thus stands for the unexceptional proposition that an FCM or AP must have written authorization to make trades against a customer's account when those trades are not specifically authorized by the customer or one designated by the customer to control the account. Peltz confuses the role the AP played in Heitschmidt with the role played by Weingarten in the coffee shop scheme. The AP, like an FCM, had to follow the instructions of a customer or one designated by the customer to control an account. These instructions had to come in one of two forms: (1) a specific authorization under 166.2(a); or (2) a written authorization under 166.2(b). The Heitschmidt AP failed to get written or specific authorization for the trades he made, thus making him liable. 34 Weingarten, on the other hand, was acting as a designee, not an AP or an FCM. Under the regulation and Heitschmidt, all SHB needed before clearing the trades was either written or specific authorization from the customer, Peltz, or the customer's designee. It did not, however, need a written authorization from Peltz giving Weingarten a power of attorney over the account. The only question for us now is, in the absence of a written power of attorney from Peltz appointing Weingarten as his designee, what type of proof will suffice, for purposes of exonerating SHB, to show that Weingarten was in fact the designee, authorized to order trades against Peltz's account? 35 There is no question that an FCM may make trades ordered by someone other than the customer himself when that someone is designated by the customer to control the customer's account. See 17 C.F.R. § 166.2. The FCM may make trades ordered by the third party who has either actual or apparent authority to make the trades. See Sansom Refining Co. v. Drexel Burnham Lambert, Inc., [1986-1987 Transfer Binder] Comm.Fut.L.Rep. (CCH) p 23,796 at 34,107 (CFTC July 20, 1987), aff'd in part, rev'd in part and remanded sub nom. Drexel Burnham Lambert Inc. v. CFTC, 850 F.2d 742 (D.C.Cir.1988). 36 Generally, before accepting trades from a third party, the FCM must make a reasonable inquiry into the nature and extent of the individual's authority. See id. p 23,796 at 34,108. Apparent authority exists when a principal, either intentionally or by lack of ordinary care, induces [the FCM] to believe that an individual has been authorized to act on its behalf. Id. (citing Wheeler v. Investment Managers Commodity Corp., [1984-1986 Transfer Binder] Comm.Fut.L.Rep. (CCH) p 22,770 at 31,220 (CFTC Oct. 30, 1984)). Actual authority is created by direct manifestations from the principal to the agent, and the extent of the agent's actual authority is interpreted in the light of all circumstances attending these manifestations, including the customs of business, the subject matter, any formal agreement between the parties, and the facts of which both parties are aware. Demarco v. Edens, 390 F.2d 836, 844 (2d Cir.1968). 37 It is not clear from the record that Weingarten had apparent authority to make the trades. We cannot say that Peltz's statements and actions reasonably induced SHB to believe that Weingarten had the power to make the trades. However, we hold that the district court's factual findings support the conclusion that, at the coffee shop, Peltz granted Weingarten the actual authority to sell all the copper futures contracts in question. 38 Only two people know what transpired across the table at Lord's Coffee Shop on that ill-fated morning. Peltz maintained that he allowed Weingarten to sell only 500 contracts at $135.50 or better. Weingarten had a different version: that Peltz granted him absolute discretion to make the trades. The district court weighed the testimony, made credibility determinations, and found that the events of that morning did not support Peltz's version of the meeting. 39 Peltz admits that he granted Weingarten authority to make some trades. It was clear to the district court that Weingarten's authority was basically unfettered. From the first trades to the last conversation of the day between the conspirators, Peltz knew full well that Weingarten was selling far more than 500 contracts and at prices below $135.50. With every phone call, Peltz received instructions from Weingarten to cover the swelling short position. Peltz did nothing to stop Weingarten from trading. Furthermore, Peltz expressly told Buzzy Mayer that he was willing to accept more than 500 trades from Weingarten so long as his position remained flat for the day. The district court was not in error when it concluded, based on this abundant evidence, that Weingarten had the actual authority to make the trades in question. 40 In some cases, the next question would be whether SHB made a reasonable inquiry into the extent of Weingarten's authority, or merely acquiesced in Weingarten's representations that he had actual authority. We need not answer this question in this particular case. Where it is clear that the designee had actual authority from the customer, it would be superfluous (as a legal matter but, perhaps, not as a practical matter) to require an FCM to make an inquiry into the designee's authority. 41 In cases of apparent authority, it makes eminently good sense to require a reasonable inquiry before imposing liability on the principal. When an FCM relies on a defense of reasonable inquiry that revealed apparent authority, we accept the defense for two reasons: (1) to encourage the FCM to make a reasonable inquiry, thereby reducing the frequency of unauthorized trades; and (2) it is unjust to hold an FCM liable after it acted in a reasonably prudent fashion. 42 These policy matters do not concern us when there is actual authority. First--and most basically--when there is actual authority there is no unauthorized trade to avoid. Second, it is unsound and illogical to hold an FCM liable when its failure to perform a reasonable inquiry did not result in the acceptance of an unauthorized trade. Hence, we hold that courts need determine if there was a reasonable inquiry only when the question is whether the designee had apparent, rather than actual authority. 43 We hasten to add, lest FCM's become lackadaisical in their everyday duties, that as a practical matter FCM's should not gamble with the possibility that the designee has actual authority. A reasonable inquiry can never hurt. Admittedly, on some occasions it will be unnecessary because the inquiry reveals that a customer granted actual authority to the designee. However, there will be instances in which a designee has only apparent authority, and the only defense from liability for the FCM will be a reasonable inquiry. 44 It follows, therefore, that SHB is not liable for the margin call. SHB was specifically authorized to accept every trade made by Peltz's designated agent, Weingarten. Hence, SHB had proper authorization to complete Weingarten's transactions under 17 C.F.R. § 166.2(a).