Court Opinion

ID: 43132
Source: CourtListenerOpinion
Date Created: 2010-04-25 21:52:18+00
Date Added: 2024-06-11T14:57:01.735237
License: Public Domain

United States Court of Appeals
                                                                                          Fifth Circuit
                                                                                       F I L E D
                      IN THE UNITED STATES COURT OF APPEALS
                                                                                         May 22, 2006
                               FOR THE FIFTH CIRCUIT
                                                                                   Charles R. Fulbruge III
                                 __________________________                                Clerk
                                        No. 05-60641
                                 __________________________

R&W TECHNICAL SERVICES, LTD., and GREGORY M. REAGAN,
                                                                                         Petitioners,

versus

COMMODITY FUTURES TRADING COMMISSION,

                                                                                        Respondent.

                  ___________________________________________________

                                   Petition for Review of
                          the Commodity Future Trading Commission
                                  CFTC Docket No. 96-3
                  ___________________________________________________

Before GARWOOD, HIGGINBOTHAM, and CLEMENT, Circuit Judges.

EDITH BROWN CLEMENT, Circuit Judge:*

         Following an earlier remand from this court, the Administrative Law Judge (“ALJ”) assessed

a decreased penalty against petitioners R&W Technical Services and Gregory Reagan (collectively

“R&W”), and the penalty was affirmed by the Commodity Futures Trading Commission

(“Commission”). On a second petition for review before this court, R&W challenges the evidentiary

rulings of the Commission in connection with the penalty determination and argues that the penalty

is excessive. We find no abuse of discretion by the Commission and, accordingly, deny the petition.

*
 Pursuant to 5th Cir. R. 47.5, the court has determined that this opinion should not be published and
is not precedent except under the limited circumstances set forth in 5th Cir. R. 47.5.4.
                                 I. FACTS AND PROCEEDINGS

        In 1992, Reagan formed R&W Technical Services to sell computer software systems that

would advise customers about trading commodity futures contracts. The software was designed to

make buy and sell recommendations to customers, after customers input real-time financial data. As

part of the advertising literature, R&W included claims of profits made while using the software.

However, the advertisements did not mention the fact that the realized profits were hypothetical;

while R&W did use actual financial data, they had never actually executed the referenced trades in

real markets with real money.

        In March 1996, the Commission’s Enforcement Division filed an administrative complaint

against R&W, alleging, inter alia, fraudulent solicitation and fraudulent advertising in violation of the

Commodity and Exchange Act. In December 1997, the ALJ found R&W liable and imposed a civil

penalty of $7.125 million, representing their gross revenues, trebled. In May 1998, R&W moved to

reopen the proceedings based on mitigating evidence of customer satisfaction. On appeal to the

Commission, in March 1999, the Commission denied R&W’s request to reopen the proceedings but

lowered the penalty to $2.375 million, representing gross revenues only.1

        R&W appealed to this court. We affirmed the decision of the Commission on the liability

issue but remanded for a reassessment of the penalty. R&W Technical Servs. Ltd. v. CFTC, 205 F.3d
165, 178 (5th Cir. 2000). We held that the Commission abused its discretion when it refused to hear

testimony of customer satisfaction because evidence of the efficacy of the petitioners’ system was

relevant in assessing sanctions. Id. at 176–77. We also held that the Commission abused its

1
The Commission found that, because there was minimal evidence of customer trading losses, trebling
was not warranted.

                                                   2
discretion in the amount of sanctions imposed against R&W. Id. at 177–78. We determined that the

Commission erroneouslyfocused on gross revenues in calculating the penalty because, when a penalty

is designed only for deterrence, the proper measure of gain to the defendant is net profits, not gross

revenues. Id. (citing CFTC v. AVCO Fin. Corp., No. 97 CIV. 3119, 1998 WL 524901, at *1

(S.D.N.Y. Aug. 21, 1998)). We concluded, “Thus, on remand a new assessment of the penalty

should begin with the petitioner’s net profits, which then should be adjusted lower based upon any

mitigating evidence the petitioners present with regard to customer satisfaction.” Id.

       Following remand, the Commission entered two orders, in August 2003 and March 2004,

setting guidelines for resolving the penalty issue. In the August 2003 Order, the Commission

provided clarification on R&W’s ability to present testimony of customer satisfaction.2 In re R&W

Technical Servs., Ltd., [2003–2004 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 29,556, 2003 WL
21805280 at *2 (CFTC Aug. 6, 2003) (“August 2003 Order”). The Commission first addressed the

form in which evidence of customer satisfaction would be admissible. The Commission found that,

because this court referred to customer “testimony” rather than affidavits, the usual condition

imposed by CFTC Rule of Evidence 10.67(f) would still apply. Id. This CFTC rule only permits the

introduction of affidavits into evidence if “the evidence is otherwise admissible and the parties agree

that affidavits may be used.” 17 C.F.R. § 10.67(f). As a result, the Commission held that only live

testimony of customers would be proper.

       Second, the Commission determined that academic studies, of the type offered by experts, did

not have a role in R&W’s case. August 2003 Order, 2003 WL 21805280 at *3 n.13. The

2
 The Commission also provided guidance on the calculation of net profits; however, the discussion
is not recounted because the parties later stipulated to R&W’s net profits for the relevant time
period.

                                                  3
Commission held that the expert testimony that R&W sought to introduce in their May 1998 motion

to reopen did not directly address customer satisfaction and fell outside the scope of this court’s prior

opinion. In the March 2004 Order, the Commission clarified that “evidence of efficacy should center

on proof of actual trading success (or failure) with the system, rather than on theoretical or

hypothetical evidence as to whether such systems can work to a customer’s advantage.” In re R&W

Technical Servs., Ltd., [2003–2004 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 29,706, 2004 WL
433573 at *1 (CFTC Mar. 4, 2004) (“March 2004 Order”).

        In October 2004, an evidentiary hearing was held before the ALJ. R&W offered customer

declarations, in the form of boilerplate letters created by R&W and signed by customers, stating

customers’ general satisfaction with the trading system.3 The ALJ sustained an objection by the

Commission’s Enforcement Division to the admission of these customer declarations in accordance

with the Commission’s August 2003 Order. At the hearing, R&W did not offer either additional

customer testimony or documentary evidence showing customers’ actual trading results.

        In January 2005, the ALJ issued a decision. See In re R&W Technical Servs. Ltd., [Current

Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 30,006, 2005 WL 56895 (ALJ Jan. 11, 2005) (ALJ

2005 Decision). The parties stipulated R&W’s net profits. As a result, the ALJ only needed to

determine if mitigating evidence would reduce the penalty. The ALJ determined that R&W failed to

present any new evidence relating to customer satisfaction or actual trading success, and, as a result,

3
 Each declaration began with a letter from Reagan to the customer stating, “The Commodities [sic]
Futures Trading Commission claims that R&W trading system is a sham. We want them to know
your opinion. We therefore ask, if you agree with the statement below, to please sign and return this
letter in the enclosed envelope.” Under the statement from Reagan, the letter stated, “I purchased
an R&W trading system. I am satisfied with the system. R&W has never participated in my personal
account, nor given me personal trading advice. The system performed at least as well as advertised.”

                                                   4
R&W was limited to evidence on the record before the remand. Id. at *3. The ALJ considered the

testimony of Thomas Otten, one of the Division’s witnesses, who traded futures contracts for his own

account and for his clients. Id. Otten had testified at the original liability hearing in August 1997

that, regardless of any R&W misrepresentations, he found the R&W system more consistently

profitable than other trading systems. Id. The ALJ deduced that Otten was a satisfied customer but

that nothing in Otten’s testimony permitted the ALJ to infer that R&W’s other customers were

similarly satisfied. Id. at *3–4. The ALJ found that R&W had not submitted other admissible

evidence on the issue of customer satisfaction, but, because Otten’s testimony was more than de

minimis, the ALJ reduced the net-profit baseline by five percent. Id. at *4. R&W’s penalty was

calculated to be $1,156,400, and Reagan’s to be $388,200. Id.

       In June 2005, the Commission summarily affirmed the decision of the ALJ, adopting the

findings and conclusions as its own. In re R&W Technical Servs. Ltd., CFTC Docket No. 96-3, 2005
WL 1505995 (CFTC June 24, 2005). R&W appeals to this court (1) contesting the evidentiary

rulings of the Commission following remand and (2) challenging the penalty imposed as excessive.

                                        II. DISCUSSION

A. The Commission’s evidentiary rulings

        R&W contests two evidentiary rulings: (1) the Commission’s exclusion of R&W’s customer

declarations, and (2) the Commission’s exclusion of R&W’s experts, Steve Corley and James

Thompson. Under the Administrative Procedure Act, this court reviews agency action for abuse of

discretion. 5 U.S.C. 706(2)(A). Additionally, because this appeal comes before this court following

an earlier remand, we also review the decision of the agency to ensure that it was reached “in due

                                                 5
pursuance of our previous opinion and mandate.” Burroughs v. FFP Operating Partners, 70 F.3d
31, 33 (5th Cir. 1995).

(1) The Commission’s exclusion of R&W’s customer declarations

       R&W claims that the Commission erred by preventing them from introducing evidence of

customer satisfaction in the form of declarations from 177 satisfied customers. It argues that this

court’s opinion explicitly stated that the Commission should have heard testimony demonstrating

customer satisfaction. However, the Commission did not disregard the mandate of this court. In our

earlier opinion, we were concerned that R&W was unable to present testimony of customer

satisfaction, but we did not address the form in which such evidence would be deemed admissible.

See R&W Technical Svcs., 205 F.3d at 177 (stating only that the Commission “abused its discretion

in refusing to reopen the record to hear [the] evidence.”).

       In the August 2003 Order, the Commission clarified the form in which the evidence of

customer satisfaction would be admissible, invoking CFTC Rule of Evidence 10.67(f). See 17 C.F.R.

10.67(f) (“Affidavits may be admitted by the Administrative Law Judge only if the evidence is

otherwise admissible and the parties agree that affidavits may be used.”). R&W presents no argument

why the Commission should not invoke this rule, except to claim that it was contrary to this court’s

holding. However, nothing in our earlier opinion suggested that it intended to abrogate the

Commission’s rules. In reviewing agency action, we routinely grant deference to an agency’s

interpretation of its own rules and regulations, and similarly here, we afford the Commission

deference in its decision to invoke its own rule. See, e.g., Barnhart v. Walton, 535 U.S. 212, 217

(2002) (“Courts grant an agency’s interpretation of its own regulations considerable leeway.”)

(citation omitted); Wang v. Ashcroft, 260 F.3d 448, 451 (5th Cir. 2001) (citing Wright v. United

                                                 6
States, 164 F.3d 267, 269 (5th Cir. 1999)).

(2) The Commission’s exclusion of R&W’s experts

       R&W also argues that the Commission erred in excluding the testimony of their expert

witnesses, Steve Corley, a technical developer at R&W, and James Thompson, a professor of

statistics. R&W states that the mandate of this court was to consider evidence of the efficacy of the

system and customer satisfaction and that their expert witnesses would address both of these points

because “scientific evidence that the R&W system was very profitable would clearly establish that

customers were likely to be satisfied.” R&W further argues that the fact that their expert testimony

is based on hypothetical results should not prevent the testimony from being admitted. It claims that,

while hypothetical results cannot be represented as actual results in advertising, they can be used as

the basis for expert testimony.

        In our prior opinion, our ruling that efficacy was relevant in assessing sanctions was in

response to the Commission’s exclusion of R&W’s proffered evidence of customer satisfaction on

the ground that efficacy of the system was irrelevant. R&W Technical Servs., 205 F.3d at 176–77.

We rejected this ground of exclusion, since customer satisfaction, to the extent it showed that

customers made and did not lose money, is relevant to a penalty determination. In so finding, we

turned to a Commission decision, In re Grossfeld, for the proposition that financial loss suffered by

customers is one of the factors in determining a civil monetary penalty. Id. at 177 (citing In re

Grossfeld, [1996–1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,931, at 44,468 & n.30,

1996 WL 709219, at *12 (CFTC Dec. 10, 1996)). In other words, in our prior opinion, we were

concerned that the Commission did not consider evidence of actual customer success or loss.

       The focus of the inquiry in assessing sanctions is on the customers. When the Commission

                                                  7
assesses a penalty against a party who commits fraud against his customers in violation of the CEA,

the Commission looks at the effect of a party’s illegal behavior on his customers. See In re Roger

Wright, Comm. Fut. L. Rep. (CCH) ¶ 29,412, 2003 WL 548760, at *51 (CFTC Feb. 25, 2003)

(stating that, in assessing a penalty, the Commission gives “primacy to harm” and that, ordinarily, “the

consequences flowing from retail-level wrongdoing include financial injury to the respondent’s

customers and financial benefit to the respondent.”). The hypothetical results of the type proffered

by R&W’s experts are, therefore, not part of the inquiry. Because the Commission’s ruling was in

accordance with the mandate of our prior opinion and consistent with the Commission’s methodology

in assessing a penalty, we find that the Commission did not abuse its discretion in excluding R&W’s

expert testimony.

B. Excessiveness of penalty

       R&W disputes the excessiveness of the penalty imposed and primarily raise two points of

error in the ALJ’s determination of the penalty:4 (1) that the ALJ gave insufficient weight to the

testimony of Enforcement Division’s expert witness Thomas Otten, and (2) that this court’s prior

opinion suggested the penalty should be capped at $100,000. Sanctions are reviewed for abuse of

discretion. R&W Technical Servs., 205 F.3d at 177 (citing Ryan v. CFTC, 145 F.3d 910, 916 (7th

Cir. 1998)). See also Wilson v. CFTC, 322 F.3d 555, 560 (8th Cir. 2003) (citing Reddy v. CFTC,

4
 R&W also argues (1) that the Commission conceded that R&W’s system was theoretically
successful, basing this claim on a statement in the Commission’s August 2003 Order and (2) that,
because the sale of their product did not constitute a social harmful activity, the high penalty was
unwarranted. Both of these arguments are unavailing. First, the Commission’s August 2003 Order
stated in its introductory section that R&W’s system was theoretically successful, summarizing the
procedural history of the case. The Commission’s statement was a description, not a concession about
the merits of R&W’s product. Second, whether the sale of R&W’s product is socially harmful is
irrelevant because that determination only becomes a factor in the so-called social-cost method of
calculating penalties. Here, the penalty determination began with a calculation of net profits.

                                                   8
191 F.3d 109, 123 (2d Cir. 1999); Vercillo v. CTFC, 147 F.3d 548, 552–53 (7th Cir. 1998); JCC,

Inc. v. CFTC, 63 F.3d 1557, 1564–65 (11th Cir. 1995)).

(1) Testimony of Thomas Otten

       As stated, Thomas Otten testified at the 1997 hearing for the Enforcement Division; he was

a registered commodities trading advisor who traded for himself and for clients. For his testimony

that he found the R&W trading system more consistently profitable than others, the ALJ reduced the

penalty by five percent. R&W argues that the ALJ should have given substantial weight to Otten’s

testimony since he was a professional who had tried several systems and used the R&W system for

his customers.

       The ALJ discussed his reasons for not imputing Otten’s success with the system to other

R&W customers at some length. ALJ 2005 Decision, 2005 WL 56895 at *3. First, the ALJ stated

that he had no evidence that other customers shared Otten’s view. Second, the ALJ noted that Otten

did not quantify how many of his customers benefitted from the R&W system nor how much was

earned. Third, the ALJ observed that, because the software was written to accommodate more than

twenty different commodity futures contracts, and because users could change a number of variables

on their own, it would be very difficult to impute the results of one satisfied customer to another.

       This court does not reweigh the evidence or substitute its judgment for the administrative fact

finder. New Thoughts Finishing Co. v. Chilton, 118 F.3d 1028, 1030–31 (5th Cir. 1997); Cook v.

Heckler, 750 F.2d 391, 392 (5th Cir. 1985). See also Guttman v. CFTC, 197 F.3d 33, 39 (2d Cir.

1999). As mandated by this court, the ALJ reduced R&W’s penalty for the mitigating effect of

Otten’s testimony. Based on various considerations, the ALJ determined that a five percent reduction

was warranted. R&W asks us to reweigh the evidence of Otten’s testimony as it relates to the ALJ’s

                                                 9
determination that only a five percent reduction was warranted, but the weight afforded particular

evidence is within the province of the ALJ, not this court.

(2) Alleged $100,000 penalty cap

       In our prior opinion, we stated, “At oral argument, counsel for the Commission was unable

to say that there had ever been a fine greater than $100,000 in a case in which there had been no

demonstration of harm to others.” R&W Technical Servs., 205 F.3d at 178. R&W argues that this

statement signifies that this court suggested a maximum penalty of $100,000 for their case. However,

our statement was an observation that counsel had been unable to cite such a case; there is no

language in the opinion which indicates we intended the explicit suggestion urged by R&W. Further,

R&W’s claim is inconsistent with our prior opinion’s remand instructions to the Commission. We

directed the Commission to begin its recalculation of the penalty with net profits, which far exceeded

$100,000. Additionally, in the ALJ’s 2005 Decision, the ALJ cited three cases where a fine greater

than $100,000 was imposed despite a lack of harm to others. See ALJ 2005 Decision, 2005 WL
56895 at *4 n.24 (citing In re First Commercial Fin. Group, Inc., [1998–1999 Transfer Binder]

Comm. Fut. L. Rep. (CCH) ¶ 27,648 at 48, 090 (CFTC May 20, 1999); In re New York Currency

Research, [1996–1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶27,311 at 46, 397 (CFTC Mar.

31, 1998); In re Glass, [1996–1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶27, 337 at

46,561–9 (CFTC Apr. 27, 1998)). Because the statement was an observation, not a suggestion, the

ALJ did not abuse his discretion by not considering the statement in the manner urged by R&W.

                                       IV. CONCLUSION

       The petition for review is DENIED.

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